Friday, November 3, 2017

Jason Zweig: "Can Fund Manager Bill Miller Use Earthquakes to Predict the Market?"

From the WSJ's MoneyBeat blog:
Bill Miller isn’t always right, but he’s never boring.

The former manager of the Legg Mason Capital Management Value Trust mutual fund beat the S&P 500 stock index for an unprecedented 15 years in a row only to lose a bloodcurdling 55% in 2008. The largest mutual fund he now runs, Miller Opportunity Trust, has outperformed 99% of similar funds over the past five years, although it lagged badly in 2016. And a hedge fund run by Mr. Miller has made a bet on bitcoin, the digital currency.

Through it all, Mr. Miller has remained one of the most interesting thinkers in the investment world, fascinated by everything from the physics of baseball to the social dynamics of ant colonies. In his latest intellectual foray, he is exploring whether the science of earthquakes can help make investing smoother.

Mr. Miller hopes to use insights from geophysics to measure when stock prices will be calm, when they will fluctuate sharply and when to reduce exposure to the market. In effect, he is hoping to develop a financial seismograph that could identify market shocks — before they occur.

So far Mr. Miller is testing the idea only in a private fund he runs for his family, Seismic Value Partners 1, that had about $15 million last December, according to a Securities and Exchange Commission filing. He isn’t using the technique in any of the accounts his firm, Miller Value Partners LLC of Baltimore, manages for outside investors.

“What we’re hoping to do is to have a quantitative model that would add value when the market’s going up and when it’s going down,” he says.

Using market prices and other measures, the system seeks to predict when conditions will favor buying or selling, and how aggressively the fund should buy or sell. It typically trades exchange-traded index funds tracking a wide selection of securities.

Mr. Miller’s son, Bill Miller IV, a portfolio manager at the firm who oversees the seismic model, says it “has done exactly what we thought it would do” since its launch two years ago. That includes doing “okay” during the extreme turbulence at the beginning of last year, when U.S. stocks slumped roughly 10% in six weeks.

John Rundle, a geophysicist at the University of California, Davis, who helped design the forecasting approach, says earthquakes and market crashes “look so much alike that you can describe them both with the same mathematics.”

Both kinds of shocks are preceded by tremors; both are followed by aftershocks. Earthquakes reach a critical point at which all fluctuations, large or small, are correlated and synchronized; in a market crash, nearly all assets tend to fall in lockstep. Financial markets, like tectonic plates, can form what physicists call a “metastable state,” temporarily harboring latent energy that gets suddenly and violently released.

Investors have long sought a reliable technique for determining when to get out of the market before a crash and back in before a rise.

Unfortunately, that holy grail remains at least as elusive as it is precious. As Cliff Asness, Antti Ilmanen and Thomas Maloney of AQR Capital Management in Greenwich, Conn., have shown, contrarian investors who tried to time the market didn’t substantially outperform those who held stocks non-stop through the booms and busts of the past six decades, without even accounting for taxes and trading costs....MUCH MORE
Previously:
April 2016
Former Legg-Mason Guy, Bill Miller, Is Running A Portfolio Using An Earthquake Prediction Algorithm
We are not fans of Mr. Miller and over the years have taken a few shots at him.
Back in a 2011 it was a post titled Fama/French: "Luck versus Skill in Mutual Fund Performance" (LMVTX):

...I dug this out of the link-vault because my memory was jogged yesterday by a post at MarketBeat quoting Legg Mason's Bill Miller. I commented that Miller was a "One-trick mo-mo pony" and that despite his record-setting 16 year run of beating the S&P he wasn't that good a manager.

In the 90's, during the middle of his streak he went with the momentum tech names. During the 2000's he switched to the momentum financials. Here's the complete record of his Legg Mason Capital Value Trust vs. the S&P 500:



...The portfolio's holdings of Countrywide Mortgage, AIG, Wachovia, Freddie Mac, Bear Stearns etc. affected performance negatively after mid 2007.

Since January 1, 2000 LMVTX has lost more than 50% vs. the S&P's 21% loss, a poor performance on either a relative or an absolute basis......
Our octa- and nona- genarian readers may recall that Joe Granville made a similar transition:
...Always remember that earthquakes can be tricky for equity analysts.
August 08's "Long-time bear joins bulls: Controversial Joe Granville says Dow could rise 800 points" had a few Granville vignettes, here's one of them:

Published: January 11, 1981 
Joseph Granville doesn't use the word ''forecasting.'' He prefers to say that he applies to the stock market a ''theory'' that he declines to reveal but whose results he communicates to clients in a weekly investment newsletter.  
Last week, as his latest bullish issue was still in the mails, Mr. Granville's theory suddenly turned bearish and advised selling. That advice, transmitted to about 3,000 clients in emergency telephone calls, triggered a selloff that drove the Dow Jones industrial average down 23.80 points and resulted in a new one-day volume record on the New York Stock Exchange. The next day, Mr. Granville predicted an earthquake of Richter magnitude 8.3 would hit Los Angeles in May.
From the New York Times:
NOTES ON PEOPLE; As a Seismologist, He's a Good Stock Analyst...
...MORE