Thursday, March 15, 2007

Where are all the Jewish Momentum Investors?

Many would find financial research a curious pursuit. And while most curious financial researchers have their own peculiar or arcane interests, one area of modern finance continues to intrigue and mystify me: "Why are there so few Jewish momentum investors?" Now before the ADL or JDL launches protest a to Blogger's management taking issue with this post before giving it a fair read, let me first clarify several points at the risk of spoiling my punchline. Firstly, by way of full disclosure, I have strong affiliations with the Tribe itself (of Abraham that is) - and little to no affiliation with the Church of Serial Correlation, the Cult of Momentum, or The Turtle Traders). Secondly, despite the fact that I am an unashamed peacenik, frequent critic of Likud, and an admirer of famous Israeli's such as Amos Oz, Y. Rabin, D. Barenboim and Y. Beilin, I AM an admirer of both the Jewish faith, and some of the things Israel has accomplished. This qualified and tepid opinion, however, does NOT - I repeat does NOT - in any way whatsoever make me anti-semitic. Thirdly, and contrary to your suspicions, the accompanying image, as any native from Calgary might tell you, strangely enough has nothing to do with the Star of David, or Momentum. It is in fact a sheriff's badge presumably labelled to express disaffection over the "mess" and chaos their annual rodeo-related Stampede creates. But it does a nice job of visually marrying my seemingly unrelated subjects.

Having dispensed with formalities and belied critics who might impugn my creditibility based upon THEIR politics, I will return to subject: the dearth of Jewish momentum traders. This puzzle initially gestated from meditations regarding the relative contribution of nature vs. nurture upon one's political beliefs. Proposing too much nature, it seems, is a contentious thought to some folk as I've discovered, for after espousing it, I've had people look upon me as puzzled and suspicious as if I were Kim Jong-Il doing a Liza Minelli impersonation, even though it's a quite innocuous observation. It goes like this. Based upon keen but anecdotal observation, populations seem to have roughly similar distributions of political archetypes between what one might broadly categorize as "progressive" or "conservative", irrespective of ethnicity, religion, or nationality of the entire population. Whether it's exemplied by Republican or Democrat, Labour or Conservative, Social Democrat or Christian Democrat there seems to be a rough equivalency in the percentages of these divisions in society. This seems to hold even if the specific ideological anchors have different coordinates in the political spectrum in different places. As other personality traits such as optimism and empathy have been shown to be strongly influenced by genetic predisposition, my probably unoriginal hypothesis by way of extension was quite simply: Why not politics? Perhaps everyone is born with a certain greater or lesser predispositon towards progressivity or conservatism, which themselves are possibly based a general affinity towards being receptive of, and embracing change (in the case of the progressive), or being cautious and suspicious of said change (as befits the conservative). The resulting conclusion: people underestimate the role of such genetic predisposition in political belief structures, in general, and in their own idelogical make-up in particular. While I am not an anthropologist nor a sociologist there are many examples of similar less-than-physical pre-disposed traits in relatively consistent proportions across varied populations (e.g. homosexuality). And while learned people who have studied this are not necessarily in agreement as to which competing theory best explains WHY the phenomena exists, there is little disgreement over the existence of the objective phenomena itself. This is NOT meant to disavow or diminish the influence of nurture, or to discount free will of the spirit which both have a role. But it is interesting, if not uncomfortable, to speculate that we may not be as free as we would like to believe.

Teleport now to the floor of the CBOT or the CBOE where mixed amongst the overly tall brokers are traders and speculators of many persuasions. Scalpers, market-makers, front-runners, discretionary liquidity providers, strategic traders, trend traders, and counter-trend traders, some disciplined, some emotional some visceral or instinctive. But here too there seems to be a similar archetypical personality divisions: that of the "trend-trader" or "counter-trend trader". One can also think of it as momentum-oriented or reversion oriented (or short-premium option traders vs long-premium option traders for our derivative friends). Might not genetic predisposition have a similar role in whether one felt more comfortable "riding a trend" or "or trying to anticipate a reversal"? Or in "buying a breakout" or "fading a pop"?? Or "Buying growth" or "buying value"? After all, these dichotomies are essentially attributable to the inherent optimism vs pessimism, or safety vs. adventuresomeness which we already have good reasons to believe are strongly influenced by nature.

Whether one agrees or not at this point, I hope you'll see a consistency and logic to this thread so far, that, if not probable, is at least plausible. Now comes the puzzle: if the general population consists of some relatively consistent distribution of, for simplicity's sake, "momentum-traders" and "reversion traders", why does there seem to be such an asymmetrical distribution specifically amongst the Jews? It's certainly not for lack of prowess at making money. Trading is in our blood and has been since our days refueling camels at the Judean cross-roads of civilisation. As a tribe, we account for some of the greatest value investors, but we seemingly can't ride a trend. Even Sol Waksal for example, whose company has the ultimate momentum theme - a cure for cancer, felt compelled to trade his position lest it's value be [temporarily] knocked by some petty little FDA concerns about experimental design. Few would argue that we are over-represented in the world of arbitrage, but under-represented amongst the great CTA's. Or that we have a keen eye for spotting and picking up the four-cent nickels, but have more difficulty sticking around to turn $1 dollar in $10. I could be way off base, but I think there is a pattern here. Is it something peculiar to "us" or is there something about momentum? Maybe it's just the "feel of it"? Or maybe it's the risk vs. reward proposition that is intuitively (or objectively) unappetizing? Or perhaps momentum requires something more of the mind or spirit, something that we simply cannot give?

It would be useful at this stage to better define "momentum". Though I am no expert on the subject, it may be helpful to separate it into different categories. One is "naive momentum" which is quite simply using past returns to predict the future direction of returns. "What's gone up will keep going up". What is outperforminmg will (hopefully) keep outperforming. For academics analyzing the stock market's cross-section of returns, this phenomena is typically viewed as relative in nature, or normalized performance ranks. Through this lens, persistence in relative return has been found to exist for as yet undiscovered and undiscernible reasons, confounding theorists - especially those espousing market efficiency. But the real Momentum-Men (and they ARE men as not a single famous woman springs to mind), are the practitioners that call themselves "trendfollowers" and would perceive themselves as more sophisticated and discriminating than the naive crowd. Here, simple moving averages give way to complex pattern matching techniques and endlessly catalogued contingency tables - all integrated systematically to find the holy financial grail which will allow them to distill the real trend that has the higher probability of persisting and thus being the motherlode that will take an ounce of gold that broke out from $454 to the stratospheric price of $5,000/oz (or beyhond!). This is a periodically prerequisite necessary to pay for for all the shakeouts, false starts, and ubiquitious reversals that are the by-product of the financial equivalent of chaos. That a number of practitioners have been reasonably (if not fabulously) successful employing these methods would seem to indicate that one dismisses them at their peril. Yet, others employing quite similar methods have crashed and burned spectacularly. But there is no shame in making (and losing) a fortune, for aside from being an adventure, it generates notoriety. And with such fame (infamy might be more accurate), one can always write a book, or post his musings on a website, or teach others to trade using trend-following techniques (but hopefully a more complete set than they used - one that incorporates counter-measures against periodically going nuclear). But perhaps the most amusing description of something with momentum was by Leif Ericson (on Peter Greenfinch's website) which he posited "was the battle between those with more money than intelligence against those with more intelligence than money.

Indeed, momentum has its uses, and has made some people (particularly brokers and exchanges, as well as some investors and traders) fabulous amounts of money. But it's not for the faint-hearted, and not without large and attendant risks. But that still doesn't answer why Jews are under- or unrepresented here. What's preventing them from joining the search for the leprechaun with real potfulls of gold at the end of the rainbow for the lucky few?

For a start, it seems that being long momentum requires faith. Similar in nature to the good old-fashioned bible-thumping fire-breathing kind. But faith in what? It's difficult to say just what that something is, and theoreticians remain perplexed. One might say it's essentially faith that the future bias of returns will continue to resemble the past. But is this wise or even acurate? It's not a bad bet with respect to things like whether the sun will tomorrow, whether the leaves will turn color this autumn, or whether the government will suddenly feel geneorous and abolish tax. And it's not unreasonable have some more-then-ambivalent confidence in a directonal movement when something is converging towards some probable equilibria. But the odds and thus confidence intuitively diminsh as one moves farther from equilibria (assuming one has a reasonably accurate estimate of probable equilibria). Consequently, risk increases. By contrast, it is "doubt" which comes easy to us Jews. Faith comes much harder. We desire proof. We NEED proof. A Covenant, for example, would work well. As would a burning bush, or some directives or commandments carved in stone. Recall, God had to crack the whip many times before people were convinced. And it took lots of smiting. And even then, there was backsliding. Moses was skeptical at first and took multiple minor demonstrations of transmutation to convince him. And I would guess that when he took his demands to the Pharoah, he probably had his doubts. At least until Pharoah's kingdom was over-run by toads. That was his nature - to doubt.

Maybe we eschew Momentum because we're just contrarians? While it's true that we are always up for a good debate, it is unfair to say that we are contrarians for the sake of it or just for kicks. Having said that, one must remember that we are wary of crowds as historically, when we Jews have seen the crowd coming, it was time to leave. And fast. Over the generations it's become burnished in our minds. But suspicion of the herd is not pathological. When there is sale on, we are the first to queue up and often lead the stampede. No obvious contrarianism there. And one must not forget that the God of the old testament is severe. He can (and often did) take away what he'd bestowed, not to mention the ever-present threat of smiting. Momentum needs time, and these things in combination have always made time an issue for us which, while it makes us good bankers, does put some behavioural boundaries upon our holding period. The old saw "One in the hand is worth more than two in the bush", would take on special meaning if one not might be around to collect.

Jews are studious, value education, and usually pretty rigorous. The faith required of a momentum investor resembles closing one's eyes when taking risk. We are used to and not shy of taking risks, but they are typially calculated risks. Like the risk of taking that "Home Office Deduction" against our income tax. We can do the math. But we disapprove of pure gambles. When was the last time you a saw one of our tribe win a large Pick-6 jackpot?!? Or when was the last time your Jewish friend invited you to go the racetrack, or wager on the greyhounds? We intuitively know lotteries are poor odds. That's why when we went to Vegas, we would rather "be the house" and "be paid" than "pay the house" and be played. When we do go to casinos as a customer its for the free drinks, and not for thrill of trying our luck against the odds. We prefer investment to speculation. At least with an investment, one can estimate probabilities and calculate expected returns. And hedge. Only then do we pray. And when we pray, we pray to God not for "good luck" but rather that the hedge holds.

Without being disparaging, momentum is useful as a discipline for people who have no other. And some form of discipline is better than none. We've an inherent intellectual flexibility which in investment terms is important in order to integrate new information and fight against hard-to-overcome cognitive biases. Maybe that's because we've always been moving and have had to learn the ways of new people and places. Unlike the way many conservative strict-constructionists in America prefer an ossified constituition, or the way fundamentalists of all religious persuasions strictly interpret their religious texts, Jews are constantly re-examing and re-interpreting the meaning of their scripture (amongst other things). Trend-following is a disciplined system that proxies for intelligence-derived flexibility. It dictates change in response to something, even if that something is facile, and often ill-logical, and frequently uneconomic. Our nature results in a demanding need to know "why" and to reach our conclusions by way of intellect, rather than faith. This creates decision flexibility (to react to, or incorporate change) which inhibits belief anchoring without sacrificing understanding.

Or perhaps we're just not optimistic enough to "close our eyes and buy"? It seems that most momentum traders are optimists by nature. Optimistic in their belief market solutions are always better. In conservative republicanism. In low taxes. I would not deny the suggestion that as a people we are not renown for our positivism. Not in art, literature, nor psychiatry. But in finance, optimism is independant of, and should not be confused with, monentum. Sometimes there is good reason to be optimistic about the direction of price movement, and sometimes not. And while I would agree that optimism serves many useful functions in the human struggle for survival, it's been shown by researchers that pessimists perception of objective reality is in fact closer to objective reality. Optimism is an important tool in sports, healing the mind and spirit or achieving personal goals, but it cannot and will not move market prices. Full stop. Objective reality (or at least reasonably accurate perception of reality), on the other hand, is extremely useful and of paramount importance when assessing probabilties, making expected return calculations, or discerning the sign and location of the fat tail..

What is the final take-away? Though untested, and unproven, the asymmetry seems to result from an unusually strong combination of natural predisposition towards progressivity inherent in our genes coupled with a multitude of social nurture factors eminating from our idiosyncratic history, religion and culture, all which reinforce our predilection for value and the counter-trend. This is not to discount the potential contributions momentum can make. But that doesn't mean we have to like it, or for that matter, pursue it, which in aggregate, we apparently don't. After all, no one really "likes" insurance, but we still buy it....

3 comments:

Anonymous said...

Cassandra,

This, surely, is a Friday pre-and-in-the bar discussion.

Excellent. Mine's a Guinness.

Rawdon

"Cassandra" said...

I recall an interview with Stephen King's editor recalling his first encounter with Mr King. King had said they should meet at a local bar whence he arrived in his softball uniform or some such. The bartender asked "What'll itbe...??" and the editor ordered a beer. The bartender looked at King to which he responded: "I'll have four...."

OldVet said...

I'm not Jewish but I played a Jew once. I was with a Saudi friend visiting his chicken farm near Medina in the mid-80's one day, and saw that people were painting all four of his delivery trucks. I asked him why, and he said he had named his company inadvertently with the name of an ancient Jewish tribe that used to inhabit the area, which tribe had been driven out by the bedouin. When the trucks rolled through the nearby town, the idle men who always inhabit the roadside in such towns threw rocks at his truck.

I decided to test his friendship, and said "I'm Jewish, you know." He smiled and said that in that case, I'd better not become a truckdriver till he got those things painted. (I tested another Saudi in those days by saying I was partly Negro, knowing most Arabs despised black people.)

So without a true feel for the genetic question, I still feel that a lot of doubt is good for investors, since there are a lot of salesmen out there, and a lot of rock throwers, no matter how much you believe in what you're doing.