Trailblazers, Heroes, and Crooks E-Book

Stephen R. Foerster

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 359

Veröffentlichungsjahr: 2024

Beschreibung

Develop a sound investment philosophy based on lessons from history

Trailblazers, Heroes, and Crooks: Stories to Make You a Smarter Investor is a highly entertaining and insightful look into key stories from history, teaching lessons about sound principles of investing, and controlling emotions and bias when managing your investment portfolio to help you become a stronger, more intelligent investor. Written by author and finance professor Stephen R. Foerster, this book spans from before the Middle Ages to the 2020s.

Some of the stories in this book include:

• Cristiano Ronaldo taking two bottles of Coke off a table at a press conference, and ostensibly causing Coca-Cola's stock value to plunge $4 billion
• Harry Markopolos trying to develop a strategy similar to Bernie Madoff's, realizing his strategy was bogus, and spending a decade proving his case
• A hostage crisis in twelfth century Venice involving trumped-up charges, conflict, deceit, a plague, and an angry mob, leading to the birth of government bonds
• A salad oil swindle almost destroying American Express, prompting Warren Buffett to make one of the best stock investments ever

For both experienced and novice investors, Trailblazers, Heroes, and Crooks: Stories to Make You a Smarter is a fun, accessible, and informative guide that through history shows, not tells, you how to develop an investment philosophy of guiding principles, and become a better investor.

Leseprobe

Table of Contents

COVER

TABLE OF CONTENTS

TITLE PAGE

COPYRIGHT

PREFACE

CHAPTER ONE: DID RONALDO MOVE THE STOCK MARKET?

RONALDO AND THE COKE BOTTLES

ANOTHER EXAMPLE OF CAUSE AND EFFECT: EX-DIVIDEND DAYS EXPLAINED

WHAT REALLY HAPPENED ON JUNE 14, 2021

THE SUPER BOWL INDICATOR

THE FACTOR ZOO

CORRELATION VERSUS CAUSATION: DON’T BELIEVE EVERYTHING YOU READ

NOTES

CHAPTER TWO: MASTERLY INACTIVITY: THE ART OF NOT ACTING

QUINTUS FABIUS

MUHAMMAD ALI

MASTERLY INACTIVITY AND SOCCER

MASTERLY INACTIVITY AND MEDICINE

MASTERLY INACTIVITY AND INVESTING

NOTES

CHAPTER THREE: OPPORTUNITY COST: WHY PAY BONILLA

NOT

TO PLAY BASEBALL

BOBBY BONILLA, THE PLAYER

DENNIS GILBERT AND DEFERRED SALARY CONTRACTS

TIME VALUE OF MONEY (TVM) AND BONILLA’S CONTRACT

THE OPPORTUNITY COST

“THE CONTRACT” NTF

SHOHEI OHTANI’S CONTRACT

TVM AND VALUING BONDS AND STOCKS

CONNECTION TO A FRAUDSTER

NOTES

CHAPTER FOUR: MADOFF’S PONZI SCHEME: TRUST, BUT VERIFY BEFORE INVESTING

BERNIE MADOFF

HARRY MARKOPOLOS

CLOSE CALL

THE CHASE IS ON

SEC SUBMISSIONS

THE WORD IS OUT

SWIMMING NAKED

SENTENCING

TOO GOOD TO BE TRUE

HISTORY RHYMES

NOTES

CHAPTER FIVE: HOW INVESTOR FOMO COST NEWTON A FORTUNE

NEWTON’S LIFE AND CAREER

THE SOUTH SEA STOCK

BURSTING OF THE BUBBLE

FOMO EXPLAINED

FOMO AND CRYPTOCURRENCIES: THE DOGECOIN EXAMPLE

AVOIDING FOMO

NOTES

CHAPTER SIX: HETTY GREEN, THE QUEEN OF VALUE INVESTING

THE PRINCESS OF WHALES

SIGNATURE MOVE

VALUE INVESTING

IT’S UP TO YOU, NEW YORK

A TREMBLING BEGINNING TO THE PANIC OF 1907

TRUST BUSTING

SELLING SHORT

BANK RUN

THE MYSTERIOUS WOMAN IN A BLACK VEIL

PANIC REDUX

BUY THINGS WHEN NO ONE WANTS THEM

NOTES

CHAPTER SEVEN: GREED AND FEAR: BUFFETT AND THE GREAT SALAD OIL SWINDLE

THE VILLAIN

THE VISIONARY

BIRTH OF THE ORACLE

THE VOICE

SCAMS AND THE DOWNFALL

THE BRAND

BUFFETT INVESTS

SHAREHOLDER VERSUS SHAREHOLDERS

GREED AND FEAR

NOTES

CHAPTER EIGHT: THEBLANK-CHECK COMPANY SCAM

THE SOUTH SEA COMPANY

THE BUBBLE ACT

THE BUBBLE COMPANIES

THE BLANK-CHECK SWINDLE OF 1720

SPACs: THE NEW BLANK-CHECK COMPANIES

DEVIL TAKE THE HINDMOST

NOTES

CHAPTER NINE: A TENNIS BOOK AND THE INDEX REVOLUTION

SI RAMO

EXTRAORDINARY TENNIS FOR THE ORDINARY PLAYER

CHARLEY ELLIS

WINNING THE LOSER’S GAME

LOSING BY EXCESSIVE TRADING

DON’T LOSE

NOTES

CHAPTER TEN: WHY SWISS BANKERS BET ON YOUNG LIVES

FINANCING FRANCE’S ANCIEN RÉGIME

TONTINES

LIFE ANNUITIES

THE SWISS INNOVATORS

THE IMMORTALS

ANCIENT PORTFOLIO THEORY

APRÈS MOI LE DÉLUGE

DON’T LOSE YOUR HEAD

NOTES

CHAPTER ELEVEN: BRE-X: ALL THAT GLITTERS ISN’T GOLD

A VERY BRIEF HISTORY OF GOLD

BRE-X HISTORY

BUSINESS INDONESIA STYLE

THE BATTLE FOR BUSANG

THE DEAL

BEGINNING OF THE END

THE COLLAPSE AND AFTERMATH

RED FLAGS

POSTSCRIPT

FALSE HOPE

NOTES

CHAPTER TWELVE: AUTOPILOTS GONE WRONG

AEROFLOT FLIGHT 593

TAKE YOUR KIDS TO WORK

AUTOPILOT OVERRIDE

“WHY IS IT TURNING?”

“TURN LEFT!”

WARNINGS

“EVERYTHING’S FINE”

AUTOPILOT FAILURES

AUTOPILOTS FOR INVESTORS

LAWRENCE SPERRY CROSSES THE CHANNEL

NOTES

CHAPTER THIRTEEN: A HOSTAGE CRISIS AND THE BIRTH OF GOVERNMENT BONDS

DOGES OF VENICE

THE RISE OF VENICE

HOSTAGE CRISIS

OUTRAGE

BIRTH OF A GOVERNMENT BOND

OUTFOXED

EVOLUTION OF THE PRESTITI

MODERN-DAY BONDS

FINAL ASSEMBLY

NOTES

CHAPTER FOURTEEN: A REVOLUTIONARY INNOVATION TO FIGHT INFLATION

THE REVOLUTIONARY WAR AND PAUL REVERE’S MIDNIGHT RIDE

MASSACHUSETTS’S ACTS

THE EARLIEST KNOWN INFLATION-INDEXED BONDS

HOW INFLATION IS MEASURED TODAY

THREE CENTURIES OF INFLATION

MODERN INFLATION-INDEXED BONDS

WHY INFLATION MATTERS

PAUL REVERE’S OTHER REVOLUTIONARY CONTRIBUTION

NOTES

CHAPTER FIFTEEN: A MARKET CRASH, RECOVERY, AND CONSPIRACY THEORIES

BACK TO 1986–1987

SETTING THE STAGE FOR A STOCK MARKET COLLAPSE

GREENSPAN’S FLIGHT

LOSING A QUARTER OF YOUR WEALTH IN A FEW HOURS

BLACK MONDAY CAUSES

SPECIALISTS’ DESPAIR

TERRIBLE TUESDAY: MORNING

THE MAJOR MARKET INDEX

TERRIBLE TUESDAY: AFTERNOON

A MIRACLE

COUNTERFACTUAL SCENARIO

NOTES

ACKNOWLEDGMENTS

ABOUT THE AUTHOR

INDEX

End User License Agreement

Guide

COVER

TABLE OF CONTENTS

TITLE PAGE

COPYRIGHT

PREFACE

Begin Reading

ACKNOWLEDGMENTS

ABOUT THE AUTHOR

INDEX

END USER LICENSE AGREEMENT

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TRAILBLAZERS, HEROES, AND CROOKS

STORIES TO MAKE YOU A SMARTER INVESTOR

BY STEPHEN R. FOERSTER

Copyright © 2025 by Stephen R. Foerster. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permission.

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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Further, readers should be aware that websites listed in this work may have changed or disappeared between when this work was written and when it is read. Neither the publisher nor authors shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data is Available:

ISBN 9781394275922 (Hardback)

ISBN 9781394275939 (epdf)

ISBN 9781394275946 (epub)

Cover Design: Wiley

PREFACE

Quintus Fabius defeated Hannibal through masterly inactivity. A hostage crisis in 12th-century Venice led to the birth of government bonds. Sir Isaac Newton had a dreadful case of FOMO and lost a fortune. A 16-year-old boy caused havoc on an Aeroflot flight when he unknowingly disengaged the autopilot. The New York Mets are paying Bobby Bonilla $30 million not to play baseball. Cristiano Ronaldo removed Coca-Cola bottles at a press conference, and caused the stock to lose $4 billion in value in a single day—or did he? After a salad oil swindle almost destroyed American Express, Warren Buffett swooped in to make one of the best investments of all time.

We’d all love to invest like Warren Buffett. We can’t all be Warren Buffett, but understanding the lessons behind his story and many other historic events can make you a smarter investor. Smart investors understand the fundamentals and sound principles of investing, like what drives the price of stocks, bonds, and other securities; why diversification is important; and how you can preserve your purchasing power. Smart investors are more attuned to avoiding pitfalls and don’t let their emotions get in the way. They simply make better investment decisions.

The goal of investing is trying to achieve the highest level of expected return for a given level of risk. The bedrock of any sound portfolio starts with stocks and bonds. Why do our portfolios start with these traditional investments? It comes back to expected return and risk, and finding the right balance. Trailblazers were the pioneers who came up with models to help us think about investments or the approach to how we invest. Trailblazers were also practitioners who helped create products for how we invest, or who encouraged a better way to invest.

Unfortunately, we may not act as smart as we can when it comes to investing. We often let our emotions and biases get in the way of sound investment decision-making. Investing success requires that we act rationally. Yet evidence suggests we don’t always act that way. For example, we often get excited and look at investment opportunities through rose-colored glasses and we’re overconfident in our stock-picking abilities. We conclude that we should invest in a company simply because it makes cutting-edge products, yet we ignore how expensive the stock currently is. We convince ourselves that we have to buy a stock now because if we don’t and the price goes up, we’ll regret it later. Yet we don’t have to let our emotions and biases get in the way. We can become smarter investors. We can learn the lessons that history teaches us.

As in life, there are heroes and crooks in the investment world. Along with the trailblazers, this book is about their stories. What they have in common is that both heroes and crooks understand the impact of emotions and biases on our investment decision-making. Crooks like Bernie Madoff play off our emotions and biases. They cause us to make poor investment decisions, ones in which only they stand to gain. On the other hand, heroes like Buffett find ways to counter emotions and biases. Some heroes look for investing opportunities when emotions have caused prices to diverge from what a security is truly worth. Other heroes take our emotions and biases totally out of the investment equation, so that we can make sound investment decisions regardless of how we feel.

What you’ll learn from the stories in Trailblazers, Heroes, and Crooks is that it pays to be diversified and start your portfolio with a strong foundation of stocks and bonds. Then be mindful that crooks are trying to play off your emotions and biases. Don’t be enticed by their false promises. On the other hand, it may pay to emulate the strategies and approaches of investing heroes. Whether you are a novice investor or a professional, you can become a smarter investor. You can learn the lessons that history teaches us to develop a sound investment philosophy. These stories about investing trailblazers, heroes, and crooks will help you to do that. And you’ll also enjoy simply reading the fascinating stories.

The stories cover over two thousand years, and originate in various locations around the world. They’re set in the Roman Empire in the second century BCE; in Venice in 1172; in the UK in 1720; in Switzerland and France in 1759; in Massachusetts in 1780; in New York City in 1907, 1987, and again in 1999; in New Jersey in 1963; in Africa in 1974; on an Aeroflot flight from Moscow to Hong Kong in 1994; in the jungles of Indonesia in 1996; and at a European soccer tournament press conference in Budapest in 2021. Buckle up because we’ll be hopping back and forth through time and space. Along the way we’ll meet seven trailblazers: Harry Markowitz, Bill Sharpe, Jack Bogle, Charley Ellis, Jacob Bouthillier Beaumont, Lawrence Sperry, Doge Vitale Michiel, and legislators for the Commonwealth of Massachusetts; eight heroes: Quintus Fabius, Muhammad Ali, Bobby Bonilla, Dennis Gilbert, Harry Markopolos, Hetty Green, Warren Buffett, and Karsten Mahlmann; and six crooks: Bernie Madoff, Sam Bankman-Fried, John Blunt, Tino DeAngelis, a promoter from Cornhill, and (alleged crook) Mike de Guzman.

I hope you enjoy the stories, and the lessons you take away that make you a smarter investor.

Stephen R. FoersterLondon, OntarioApril 2024

CHAPTER ONEDID RONALDO MOVE THE STOCK MARKET?

Who’s the best soccer player in the world? Well, it depends on how you ask and whom you ask. Asking who’s the best player of all time may elicit a different answer than asking who’s the best active player. And of course, the answer will be subjective. In 2022 prior to the World Cup, one list1 had the top three active players as Lionel (Leo) Messi, Cristiano Ronaldo, and Neymar da Silva Santos, Jr. (known simply as Neymar). Born in Argentina, Messi was named the Fédération Internationale de Football Association (FIFA) world player of the year six times, and, by the time he was only 24, had scored 233 goals for Barcelona to become the fabled club’s all-time leading scorer.2Ronaldo, born in Portugal, was a five-time FIFA world player of the year, and in the 2017–18 season, playing for Spain’s Real Madrid, scored 44 goals in 44 games.3 Neymar, born in Brazil and one of the country’s most productive scorers, played for Barcelona between 2013 and 2017 and was a chief contributor to the club’s success.4

Who’s the greatest social media influencer in the world? If we narrowly define what we mean by influencer, this question has a more objective answer. Based on Instagram followers as of 2024, it’s not even close. And it turns out to be one of the three top soccer players. Messi had 496 million followers. But Ronaldo was a clear number one with a whopping 616 million followers—now that’s influence! (In case you were wondering, Selena Gomez was in the number-three spot with 429 million followers.)

RONALDO AND THE COKE BOTTLES

Here’s a story you may have heard about that speaks to Ronaldo’s influence beyond the soccer pitch. This headline from the Washington Post, on June 16, 2021, said it all: “Cristiano Ronaldo snubbed Coca-Cola. The company’s market value fell $4 billion.”5 The article referred to an incident at a press conference on June 14, 2021, during the 2020 European Championship (postponed until 2021 due to the Covid-19 pandemic). At the start of the press conference in Budapest, before Portugal played Hungary, Ronaldo proceeded to remove two bottles of Coke that were prominently displayed on the table in front of him. This was shocking because Coca-Cola was one of the tournament’s official sponsors. He replaced them with a bottle of water, saying, “Agua. No Coca-Cola.” It was immediately big news. A YouTube video of the incident has been viewed over 22 million times.6 (Portugal went on to beat Hungary three to nil, with Ronaldo scoring late in the match on a penalty kick, and another one in stoppage time.)

The Washington Post article was very conclusive: “The simple gesture [of moving the Coke bottles] had a swift and dramatic impact: The soft drinks giant’s market value fell $4 billion, highlighting the power and impact that celebrities and influencers can have on the market.” That implies a clear cause-and-effect. The cause was the action by Ronaldo, a celebrity and influencer, snubbing Coca-Cola by removing Coke bottles. The effect of Ronaldo’s action was a substantial drop in the market value of Coca-Cola. Case closed! Or was it? Let’s take a closer look.7

ANOTHER EXAMPLE OF CAUSE AND EFFECT: EX-DIVIDEND DAYS EXPLAINED

But first, an important digression and explainer of another example of cause and effect. This one doesn’t involve influencers. Established companies like Coca-Cola pay regular cash dividends, usually on a predictable quarterly cycle. The timing of upcoming dividend payments isn’t a surprise to the market because companies announce their plans ahead of time. There is a cutoff point, known as the ex-dividend date, and that’s announced in advance as well. After that date, anyone who becomes a new owner of shares doesn’t receive the imminent dividend.

Here’s a simple hypothetical example. On May 1 a stock is selling for $10 per share. There’s an upcoming dividend of $1 per share to be paid on May 15. The ex-dividend date is May 2. The stock is priced at $10 in anticipation of the upcoming $1 dividend. If you own the stock on May 1, you’ll be getting the upcoming dividend. Then on May 2 the stock trades ex-dividend, which means anyone buying shares on that day or later won’t be receiving the upcoming May 15 dividend. So, unless there’s new information relevant to the stock’s value, we would expect the stock to drop by $1 on May 2, the ex-dividend date.

Here’s a real example. June 14, 2021, was an ex-dividend date for Coca-Cola.8 That meant that anyone who first bought the stock on that date wasn’t eligible for the $0.42 per share dividend that was going to be paid on July 1. With 4.3 billion shares outstanding, that’s a total cash payment of about $1.8 billion. So, absent any other relevant information, we would expect Coca-Cola’s market value (stock price times the number of shares) to drop by that amount on the ex-dividend date. For anyone who owned the Coca-Cola shares prior to June 14, 2021, the anticipated share price drop wouldn’t affect their overall wealth since they were entitled to the upcoming cash dividend. June 14 just happened to coincide with the day of Ronaldo’s press conference.

WHAT REALLY HAPPENED ON JUNE 14, 2021

Now let’s see what was really happening with Coca-Cola’s stock around the time of the infamous snub. On Friday, June 11, Coca-Cola’s stock price closed at $56.16 a share. The company’s shares had an overall market value of $242.6 billion. On Monday, June 14, when the market in New York opened for trading at 9:30 a.m., the stock was at $55.69. That price was down $0.47 a share since Friday’s close, or a market value decline of $2.0 billion. In the absence of any major news over the weekend, we would have expected the stock to drop by $0.42 a share, the amount of the upcoming dividend, or overall by the total cash payment of $1.8 billion. That’s fairly close to what actually happened. The S&P 500 index, a broad measure of the overall U.S. stock market, hadn’t moved much between its Friday close and Monday opening. It was up just 0.02 percent, and so that didn’t seem to impact on Coca-Cola’s opening price.

Coca-Cola’s stock price continued to drop during the next several minutes, from $55.69 at the 9:30 a.m. open to $55.27 at 9:43 a.m. By that time, the overall Coca-Cola stock value had declined by $3.9 billion since the Friday closing value. That sounds like a lot of money. But to put that in perspective, it’s just 1.5 percent of the Friday value. Furthermore, half of that amount (0.75 percent or $0.42 per share) was because of the ex-dividend date effect. Subsequent to the June 14 market opening, the S&P 500 index declined only slightly, so we can conclude that there was some other reason that caused the unexplained drop of about 0.75 percent. Perhaps it was related to the outlook for Coca-Cola or the beverage industry. But that’s not surprising. New information and changes in investor expectations cause stock prices to move all of the time.

What’s important is that Coca-Cola’s stock price drop occurred prior to the start of Ronaldo’s press conference. Ronaldo removed the Coke bottles at 9:43 a.m. (New York time). From 9:43 a.m. through the remainder of the trading day, Coca-Cola’s stock price actually rose, both in absolute terms as well as relative to the overall market. It went from $55.27 to $55.55. So how about this for a revised story headline: “Cristiano Ronaldo snubbed Coca-Cola. The company’s market value then rose by $1.2 billion.” If that was the new headline, would we then try to infer cause-and-effect and conclude that Ronaldo was a past-his-prime-has-been and no longer an influencer?

Let’s go back to the Washington Post headline: “Cristiano Ronaldo snubbed Coca-Cola. The company’s market value fell $4 billion.” Taken literally and separately, each sentence is a true statement. There’s no question that Ronaldo’s removal of the Coke bottles and his statement “No Coca-Cola” was a deliberate snub. And based on the change in Coca-Cola’s closing stock prices between Friday, June 11, and Monday, June 14, Coca-Cola’s market value dropped by more than $4 billion. But placed together, the implication is that one thing caused the other. That’s clearly not what happened.

Correlation describes the extent to which two things are related to one another. Is there a correlation between the snub and the stock price decline? Yes, as they both occurred on the same day. But the evidence indicates that within that particular day, the snub didn’t cause the drop in the stock price. What we do know—and is well established—is that Coca-Cola’s stock going ex-dividend was the primary cause of the price decline at the opening of trading.

A few days later, an Associated Press article was much more accurate than the Washington Post article when it stated, “A drop in Coca-Cola’s share price this week was attributed by some to Ronaldo’s snub, but without any evidence that the two things were connected.”9 Understanding the ex-dividend date effect and examining intraday prices on June 14, there’s no question that Ronaldo’s press conference snub didn’t cause Coca-Cola’s stock price to drop that day. There’s an important distinction between correlation and causation, yet we often confuse the two.

THE SUPER BOWL INDICATOR

Classic correlation versus causation examples abound. Here’s one that connects sports with stocks. It isn’t very often that the prestigious academic publication the Journal of Finance publishes a paper about sports. One such paper, in the June 1990 issue, was titled “An Examination of the Super Bowl Stock Market Predictor.”10

The Super Bowl dates back to January 15, 1967, when the American Football League (AFL) and the rival National Football League (NFL) agreed to have their respective champions play in the first World Championship Game (as it was initially called). The NFL’s Green Bay team defeated the AFL’s Kansas City team 35 to 10.

As early as 1978, a pattern was detected. Sporting News noted that between 1967 and 1977, whenever one of the original NFL teams won the Super Bowl, played in January during that era, the stock market rose over the remainder of the year and ended higher overall for the year. The reverse was true if an original AFL team won the Super Bowl.11 This happened in each of 11 consecutive years.12 The 1990 paper updated the analysis through 1988 and found that the predictor was correct 20 out of 22 times, for an accuracy rate of 91 percent. The average annual return differences for the S&P 500 index were astounding: 15.3 percent if an NFL team won, versus –10.9 percent if an AFL team won.

So what’s happened to the Super Bowl predictor since 1988? According to one study, between 1989 and 2016, the predictor’s success rate dropped to 61 percent.13 And if we account for the more recent Super Bowls through 2023, that percentage drops to a near-coin-flip 51 percent (18 out of 35). In other words, it’s not much of a predictor. But we shouldn’t be surprised. It’s hard to come up with a solid argument why a Super Bowl win by an original NFL team should cause the stock market to go up.

THE FACTOR ZOO

Correlation analysis plays a major role in investing strategies known as factor investing. Factor investing is a strategy that tries to identify stock investment opportunities by looking for relationships between stock price movements and quantifiable measures. For example, a stock’s returns might vary as overall market returns vary: if the S&P 500 index goes up, then Walmart’s stock might go up as well, and vice versa if the market declines. Other factors might be related to a firm’s earnings. For example, “value investors” look for stocks that might be reasonably priced relative to current earnings, while “growth investors” look for stocks with expectations of hyper-growth in revenue or profits. For value investors, a firm’s price-to-earnings ratio is an important factor to consider when buying a stock. For growth investors, expected growth is an important factor.

The idea behind factor models can be traced to Nobel laureate Harry Markowitz in his 1959 book Portfolio Selection.14 Markowitz’s investment model showed that as long as stock prices don’t move in lockstep, there are benefits to being diversified—in other words, owning a portfolio of stocks rather than just one or two. That’s because while one stock might be down on a given day or week, others might move up, and so the overall portfolio will be less volatile. He showed that there actually is a free lunch. With a portfolio, you can get a better overall return relative to risk.

Factor models were popularized by his protégé William (Bill) Sharpe, with whom Markowitz shared the Nobel Prize in Economics. In his 1963 paper, Sharpe created a simple model with one factor. Security returns were related to one another only through some basic underlying factor such as the overall stock market, gross national product (GNP), or “any other factor thought to be the most important single influence on returns from securities.”15 In Sharpe’s 1964 paper, he created an equilibrium model that became known as the capital asset pricing model or CAPM. Instead of assuming a single factor, he derived it. It turned out to be the market portfolio of all investable assets.16

In Sharpe’s model, the best way for investors to act was to put all of their money in this market portfolio, and then borrow or lend depending on risk preference. If you were well-diversified, then it really didn’t matter how risky one stock was on its own. All that mattered for that stock was how risky it was relative to the overall market portfolio. A measure of that relative risk became known as beta. In the mid-1960s, there wasn’t any mechanism to efficiently invest in a market portfolio. Today we have low-cost index funds.

There’s an important implicit cause-and-effect in the models like Sharpe’s. An increase in the overall stock market causes an individual stock to go up by a certain proportion. For example, if there is some unexpected good news on how the overall economy has been performing, investors may revise upward expectations for future profits for particular companies. But the relationship isn’t necessarily one-to-one.

The popularity of factor investing has increased as quantitative data related to stock characteristics has become more readily available. John Cochrane, former president of the American Finance Association, coined the term “factor zoo” to describe the proliferation of factors in these models that try to develop an investment strategy that will outperform.17 Sample factors include dividend-to-price ratios, unexpected earnings, leverage, price momentum, and volatility, to name just a few. Some models have dozens of factors that are used to explain and predict future stock returns. Unlike Sharpe’s theory-based capital asset pricing model, most of these models are developed by back-testing strategies on historical data. Quite often, the back-test results look much more promising than actual results once a strategy has been implemented. That’s no surprise, and it gets at the heart of correlation versus causation. If 100 factors are tested and five seem to be good predictors of future stock returns, it may be that those five showed statistically significant relationships just by happenstance—like the Super Bowl indicator.

CORRELATION VERSUS CAUSATION: DON’T BELIEVE EVERYTHING YOU READ

What are we to make of all of this? Here are short captions from a nerdy cartoon that distinguishes between correlation and causation.18

Person 1:

“I used to think correlation implied causation. Then I took a statistics class. Now I don’t.”

Person 2:

“Sounds like the class helped.”

Person 1:

“Well, maybe.”

Proving a particular factor causes stock price movements is very difficult, as stock prices are driven by all kinds of information. Some factors may impact the overall market, like economic news, and some are specific to a particular firm, like its earnings. At best, we can look for evidence of correlation coupled with a plausible explanation that is isolated from other possible explanations. But even that isn’t a guarantee. In the case of the Ronaldo snub, the Washington Post and many other news outlets overlooked important information, the missing link related to the ex-dividend date.

The Washington Post reporter who wrote about Ronaldo’s snub covered breaking news and national stories and wasn’t a finance expert.19 She wasn’t deliberately trying to create “fake news.” The message here isn’t to distrust mainstream news outlets but rather to gather as much relevant information as you can before jumping to any conclusions, or making any decisions. Correlations are all around us, and in particular in the world of investments. It doesn’t hurt to start from a skeptical perspective. Then, based on extensive evidence, you’ll need to be really convinced of a causation story.

There’s no conclusive evidence that by moving the Coke bottles, Ronaldo destroyed Coca-Cola shareholder value. Even if he succeeded in getting his followers to drink more water, it’s not even clear what impact that would have had either. According to the Guardian, the bottle of water that Ronaldo replaced the Coke bottles with was also a Coca-Cola product.20

NOTES

1.

Delanty, Gavin, “Top 10 Best Soccer Players in the World,”

Lineups.com

,

https://www.lineups.com/articles/top-10-best-soccer-players-in-the-world/

.

2.

Britannica, Lionel Messi,

https://www.britannica.com/biography/Lionel-Messi

.

3.

Britannica, Cristiano Ronaldo,

https://www.britannica.com/biography/Cristiano-Ronaldo

.

4.

Britannica, Neymar,

https://www.britannica.com/biography/Neymar

.

5.

Villegas, Paulina, “Cristiano Ronaldo Snubbed Coca-Cola. The Company’s Market Value Fell $4 billion,”

Washington Post

, June 16, 2021,

https://www.washingtonpost.com/sports/2021/06/16/cristiano-ronaldo-coca-cola/

.

6.

“Cristiano Ronaldo HATES Coca-Cola,” YouTube, June 14, 2021,

https://www.youtube.com/watch?v=_nw7FOgOgtA

.

7.

Facts relating to what happened that day were described in Nuno Fernandes, “A Post-Truth World: Why Ronaldo Did Not Move Coca-Cola Share Price,”

Forbes,

June 19, 2021,

https://www.forbes.com/sites/iese/2021/06/19/a-post-truth-world-why-ronaldo-did-not-move-coca-cola-share-price/?sh=59fa67fefbb

.

8.

Nasdaq, “Coca-Cola Company (KO) Ex-Dividend Date Scheduled for June 14, 2021,” June 11, 2021,

https://www.nasdaq.com/articles/coca-cola-company-ko-ex-dividend-date-scheduled-for-june-14-2021-2021-06-11

.

9.

“UEFA Warns Euro 2020 Teams to Leave the Coke and Heineken Bottles Where They Are,” Associated Press, June 21, 2021,

https://www.marketwatch.com/story/eufa-warns-euro-2000-teams-to-leave-the-coke-and-heineken-bottles-where-they-are-01624301933

.

10.

Krueger, Thomas M., and William F. Kennedy, “An Examination of the Super Bowl Stock Market Predictor,”

Journal of Finance

45, no. 2 (1990): 691–697,

https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1990.tb03712.x

.

11.

Koppett, Leonard, “Carrying Statistics to Extremes,”

Sporting News

, February 11, 1978.

12.

The 11 for 11 accuracy depends on the definition of the stock market. It is true based on the New York Stock Exchange (NYSE) index, but slightly off based on the S&P 500 index. This is because in 1970, when Kansas City won the Super Bowl, the indicator predicted markets would decline. As predicted, the NYSE index was down, by 2.5 percent, while the S&P 500 index was essentially flat, up by only 0.1 percent for the year.

13.

Schmidt, Bill, and Ronnie Clayton, “Super Bowl Indicator and Equity Markets: Correlation Not Causation,”

Journal of Business Inquiry

17, no. 2 (2017): 97–103.

14.

Markowitz, Harry,

Portfolio Selection: Efficient Diversification of Investments,

Cowles Foundation for Research in Economics at Yale University, Monograph 16 (New York: John Wiley & Sons, 1959), 96–101.

15.

Sharpe, William, “A Simplified Model for Portfolio Analysis,”

Management Science

9, no. 2 (1963): 277–293.

16.

Sharpe, William, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk,”

Journal of Finance

19, no. 3 (1964): 425–442.

17.

Cochrane, John, “Presidential Address: Discount Rates,”

Journal of Finance

66, no. 4 (2011): 1047–1108.

18.

xkcd webcomic,

https://xkcd.com/552

, CC BY-NC 2.5.

19.

“Paulina Villegas,”

Washington Post,

https://www.washingtonpost.com/people/paulina-villegas/

.

20.

“Coca-Cola’s Ronaldo Fiasco Highlights Risk to Brands in Social Media Age,”

Guardian,

June 18, 2021,

https://www.theguardian.com/media/2021/jun/18/coca-colas-ronaldo-fiasco-highlights-risk-to-brands-in-social-media-age

.

CHAPTER TWOMASTERLY INACTIVITY: THE ART OF NOT ACTING

The term “masterly inactivity” may conjure up an image of laziness or procrastination, but it’s much more nuanced than that. It’s a versatile concept, applying to a broad number of contexts such as warfare, the boxing ring, soccer, medicine, and investments. Let’s start with a definition for masterly inactivity from Fine Dictionary: “The position or part of a neutral or a Fabian combatant, carried out with diplomatic skill, so as to preserve a predominant influence without risking anything.”1 Simply and more broadly stated, masterly inactivity is the art of knowing when not to act.

QUINTUS FABIUS

That dictionary definition refers to the successful strategy employed during the Second Punic War (218–201 BCE) by the Roman dictator Quintus Fabius. He was known as Fabius Cunctatus or “the Delayer” and we’ll see why.2 He also earned the nickname “Maximus” among Romans—akin to calling rock star Bruce Springsteen “The Boss.” Fabius showed how a weaker party can patiently overcome a stronger one.

Fabius was a cautious, composed, soft-spoken child. He was nicknamed ovicula, “the little sheep.” His cool temperament and dispassion were initially misinterpreted as signs of a mental disability. Yet he eventually became one of Rome’s ruling elite.

In the early third century BCE, both Rome and Carthage had expanded their territories in the western Mediterranean area. That put them on an inevitable collision course of superpowers. They fought a lengthy war between 264 BCE and 241 BCE without resolving longstanding issues between them. In 219 BCE, Carthaginian Hannibal Barca emerged as one of the greatest military commanders in history, with the capture of Saguntum, a recent ally of Rome in present-day Spain. At age 28, the young Hannibal assaulted, enslaved, and slaughtered the people. Rome was furious and sent its legions to defeat Hannibal. He eluded them by invading northern Italy, famously crossing the Alps with war elephants.

Hannibal’s army ravaged Italy in victory after victory, both in skirmishes and major battles. Despite huge losses, many Roman senators felt the best strategy was direct confrontation with Hannibal’s army. That played into the Carthaginian’s plan: not to capture Rome, but to occupy as much territory as possible before forcing a peace. Realizing that Hannibal’s forces were superior, Fabius decided to deny Hannibal the battles he was looking for until the Roman army could be reinforced.

Fabius was appointed dictator, with vast powers. He took personal command and encamped his troops at Aecae, a town in the Apulia region in southern Italy. When Hannibal learned of their nearby encampment, he resolved to terrify the Romans by attacking. But as his army approached and prepared for a great battle, there was no response from Fabius. Hannibal’s army retreated to their camp.

Fabius knew that his army was inferior, and so his strategy was to bide his time rather than risk defeat in battle. Fabius reasoned that his army was on home turf and close to supplies and more men. By waiting he could amass a larger army. His tactic was to engage in the occasional skirmish in order to maintain morale, but to avoid a frontal battle until he felt the time was right, in a low-risk, high-gain scenario. Eventually his patience paid off, and Fabius was able to secure an unexpected military victory. Masterly inactivity was born.

MUHAMMAD ALI

One of the greatest boxers of all time, Muhammad Ali, employed a Fabian strategy in the boxing arena against George Foreman. (You may recognize Foreman’s name for another reason. Post-retirement, Foreman was a promoter of the iconic grill that bears his name and that made him richer than through all of his boxing fights.) Their famous World Heavyweight Championship bout occurred on October 30, 1974, in Kinshasa, Zaire (now the Democratic Republic of the Congo), and became known as the “Rumble in the Jungle.”3

Ali, born Cassius Clay, had been the world champion until 1967. As a conscientious objector, he refused to serve in the U.S. Army during the Vietnam War. He was imprisoned, lost his boxing license, and was stripped of his championship title. In 1970, he was back in the ring, and handily defeated Jerry Quarry. Then Joe Frazier beat Ali in 1971 in the “Fight of the Century.” Over the next three years, Ali then beat Frazier, lost in a split decision to Ken Norton, and racked up a total of 13 wins. At age 32, Ali was clearly past his prime, more flat-footed and less of a dancer in the ring. He entered the fight against Foreman as a 40-to-1 longshot with some bookmakers. Many feared for Ali’s safety against the younger (age 25), heavier Foreman, who also had a longer reach.

With a thunderstorm advancing, Ali arrived at the outdoor stadium—once used as an execution chamber for dissidents—wearing a white satin robe with an African blanket trim. Nearly 60,000 spectators looked on. Foreman was the reigning champion, unbeaten in 40 fights and with 37 knockouts. His opponents hadn’t lasted more than three rounds before getting knocked out. Only one other person, Floyd Patterson, had been able to regain the heavyweight title, in 1960. This was clearly an uphill battle for the underdog Ali.

In the first of the scheduled twelve rounds, Foreman pinned Ali to the ropes and slammed punches with both hands to Ali’s rib cage, with Ali protectively covering up. At the end of the round, sitting on a stool in his corner, Ali winked at Foreman. In the second round, Foreman chased Ali and pinned him against the ropes. Ali appeared to be wobbly. In the third round, Ali lay on the top rope and let Foreman punch away at him.

At the end of the round, instead of resting on his stool, Ali went over to a ringside TV camera and, hamming it up, made a face. In the fourth round, Ali again lay against the ropes while Foreman jabbed at him. Foreman’s legs started to look weary. The fifth round proceeded much like the others, with Ali on the ropes. Before the sixth round, an official was trying to tighten the top rope where Ali had been laying against, but inadvertently loosened it. So Ali avoided that section.

By the seventh round, Foreman was stumbling. He chased Ali, but Foreman’s face had become puffy, especially around his right eye, which he had cut during training. In the eighth round, Ali suddenly hit Foreman with a left-right combination. Foreman veered and collapsed on the canvas, with his dazed head rising briefly. Ali had delivered a stunning knockout. Soon after the fight finished, dawn broke, and a heavy rainstorm poured down.

Ali had deployed an unusual strategy that became known as rope-a-dope. Foreman threw 461 punches to Ali’s 252, and landed 194 to Ali’s 118.4 Instead of meeting Foreman in the center of the ring, Ali leaned back against the ropes, protected himself, and let the elastic ring ropes absorb much of the force from Foreman’s blows. Like Fabius centuries earlier, this was one of the greatest examples of masterly inactivity.

MASTERLY INACTIVITY AND SOCCER

Arguably the most exciting play in soccer (or football to our non–North American friends) is the penalty kick. It occurs either when one team commits a serious offence close to the goal, or when a game is tied after regulation and extra time. The ball is placed 12 yards from the goal. The goalkeeper must remain on the goal line until the ball is struck by the kicker. Four-fifths of penalty kicks result in a goal. That’s significant because on average there are only 2.5 total goals scored in any given game.