The matrix

DOUG  By Guest Blogger Doug Rowat

It’s been a great year for markets and most investors could probably rhyme off their 2019 winners at the drop of a hat—“my junior mining stocks are killing it!” It’s fun to brag. However, what’s less likely is that these same investors could tell you how these winning positions fit into their overall portfolio mix, how they control or contribute to volatility or how they improve or detract from downside capture. In other words, most investors have little to no idea how their portfolio positions are correlated to one another.

Why? Because discussing low-to-negatively correlated off-setting portfolio holdings, which are designed to control risk over the long term, is a far less sexy conversation than discussing a 25% one-month gain from a small-cap mining stock.

But if your risk tolerance is untested and you’ve never experienced a US recession with meaningful money at stake (and many haven’t—it’s been more than 10 years since the last one) then understanding security correlation becomes critical. It’s fun when all your holdings are moving higher together, but far less enjoyable when they all move down at the same time.

Many investors are aware that we experience portfolio losses much more acutely than gains. It’s irrational, but we can’t help it, and in down markets, we make terrible investing decisions as a result. Mainly, we sell at incorrect moments because the emotional pain of the losses becomes too great. Interestingly, the pain of losses is not limited to our investments—it actually infects almost every part of our lives. In fact, loss aversion is so ingrained in our DNA that it even affects the way we order pizza. Psychology Today highlights as much:

…consumers were asked to either build up a basic pizza by adding ingredients (e.g., sausage and pepperoni), or scale down from a fully loaded pizza by removing ingredients. Consistent with loss aversion, consumers in the subtractive condition ended up with pizzas that had significantly more ingredients than those in the additive condition.

So, there’s little we can do about losses having a much larger psychological impact than gains, but what we can do to assist with this psychological blind spot of ours is build a portfolio that limits losses. What is needed is a balanced portfolio that reduces emotional pain by limiting the downside in tough markets.

But how do we know that our portfolio is likely to do this? By building a correlation matrix of all holdings and examining how each piece of the portfolio is likely to move directionally with the price action of all the other pieces. All correlations range between 1 (components move in perfect lockstep) to -1 (components move in the exact opposite direction to each other). A correlation matrix is useful because it visually indicates the number of assets that are highly correlated and the number of assets that have low-to-negative correlations. If you want to avoid the dangers of loss aversion, a portfolio should have plenty of the latter assets.

To illustrate, the sample correlation matrix on the top suggests a portfolio that is much more likely to protect on the downside than the sample matrix on the bottom. Without overcomplicating the matter, to better control risk, you want a matrix that is more colourful. However, the main problem for most investors is colour blindness—they have no idea whatsoever how any of the securities in their portfolio interact with one another.

Which portfolio is better diversified?

Source: Vanguard

There are plenty of websites or software programs that can assist with building a correlation matrix. Or you can hire an advisor to do the work for you. This work can be painstaking especially when consideration is given to adding or subtracting positions, but it’s necessary to truly understand the exact kind of investment portfolio that you’re building for yourself.

It’s one thing to say that your portfolio is balanced and diversified, but it’s something else entirely to prove it.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

 

58 comments ↓

#1 Ponzius Pilatus on 09.21.19 at 12:38 pm

#67 S.Bby on 09.21.19 at 11:42 am
The blackface scandal is quickly dying down as the left is giving Trudope a pass on this one because he is one of them. If this was Andrew Sheer or anyone else to the right side we’d be hearing of the outrage for weeks on end.

Why can nobody spell “Scheer”? – Garth
———-
He’s of Austrian stock.
So I call him Herr Scheerer.

#2 leebow on 09.21.19 at 1:19 pm

For retail investors, the main two problems with this analysis are.
1. Regime change – things that are uncorrelated on the way up could be very correlated on the way down.
2. Your trading strategy may introduce way more risk and volatility than you can diversify away using this type of analysis. If you panic sell, all prior analysis will prove useless.

Doug, what do you do for factor analysis/allocation?

#3 Flop... on 09.21.19 at 2:01 pm

Hey WULLY, if you are doing any renovations you might want to hold off painting your spare bedroom navy blue and white, as your beloved Geelong Cats have been knocked out of the Australian Rules finals.

Dogs are out too, canine lovers.

It’s the Tigers vs Giants in this years Australian Super Bowl.

If you are drowning your sorrows, may I suggest Trump’s favourite drink, a White Russian.

Benefits included, getting drunk, and looking after your aging bones at the same time…

M45BC

#4 Stan Brooks on 09.21.19 at 2:04 pm

Negatively correlated securities are normally acting as a hedge for main ‘theme’ investment which itself is diversified across major economies.

However risk profile should be adjusted based on short and long term business/monetary cycle.

i.e. portfolio allocation should change both across economies and sectors and across type of securities based on where we are in the business/credit cycle.

Considering where we are NOW and the impediment with the interest rates, inflation hedges – positively correlated with inflation will outperform in the short to mid, term – the next 10-15 years.

Specific utilities, REITs, specific energy companies, gold – focusing on value companies.

Don’t be afraid of individual securities, I have over 40 individual securities that outperform indexes big time in terms of income and growth.
I love ENB, it is a great pleasure to capitalize on the miserable life of the sheeple.

Expecting nominal interest rates to go negative, bond ETFs are not a bad place to be at the moment.

We will have nominal negative rates in 3-5 years here, it is a given, we already had 10+ years with strongly negative real rates.

Inflation is coming folks, big time. In food, groceries, energy, services.

Exploring Lepanto – Solera Gran Reserva today.
Cheers,

#5 conan on 09.21.19 at 2:18 pm

“The blackface scandal is quickly dying down . ”

Not surprised as it does not pass the smell test.
We would have heard about this back in 2001, if anyone in attendance, was remotely offended.

Everyone they talk to, who was there, had no problems…
JT was an actor playing Disney’s Aladdin in a school play…..

Typical cons screaming like banshees about nothing.

Would I vote for the Great white shark because the life guard said a bad joke? No I would not and most of Canada is the same way, except for crazy Cons.

#6 FreeBird on 09.21.19 at 2:20 pm

Get a BD portfolio and plan then enjoy the last of warm days. Watch the local air show from the back deck, clean up the patio or…look at more hugging animal gifs. Feel free to add beer or wine or not. Life’s short.

https://tenor.com/search/dog-hug-gifs

#7 Not So New guy on 09.21.19 at 2:44 pm

For Ants:

One part boric acid (aka Borax. Very inexpensive and found in most grocery stores) to six parts sugar mixed in water.

The ants go mad for it and then they take it back to their colony which they feed to the queen. She is the source of your problem so you will kill them at their source. It costs pennies and works relatively quick.

Videos on you tube

#8 Wally Waffles on 09.21.19 at 2:45 pm

Can one be to diversified, so would building a correlation matrix not also address this?

#9 Flop... on 09.21.19 at 2:49 pm

Robax, I like the subtlety of the photo with the subject of the week.

Very clever.

You found a photo of two white dogs, with one of them dressed up as a black dog…

M45BC

#10 Scheer Weakness on 09.21.19 at 2:50 pm

Poor Andy taking the day off from campaigning, too clueless to figure out what to say now.

Weak.

#11 Tannhäuser Gatekeeper on 09.21.19 at 2:53 pm

The road to perdition is paved with correlation matrices.

For the amateurs and the long-only buy side, they are the pivot point where the Prime question becomes not “is this a good investment,” but “how does it correlate with my current portfolio.”

For the PMs and the pros, “how much moar leverage does the VaR model say I can use.” … notwithstanding that the entire edifice of models is build on an assumption of Gaussian distributions of returns. Which, yeah, everyone knows is false, but it makes the models tractable.

Maths like this, applied to investing, made paupers and fools of two Economics Nobel recipients. I’m guessing that for someone investing their own money, it’s more likely to lead to analysis paralysis (maybe a cause, or maybe a symptom) than to any appreciable number of basis points of added return.

#12 Rob in Frankfurt on 09.21.19 at 3:49 pm

Yupp, mentioned to my nephew that you don’t understand risk tolerance until you’ve logged into your account and see it down 25%. That is where you really test your metal. Are you paralyzed with fear or do you look and see what where is going on. A correction to be ignored or an investment mistake to be learned from.

The good news is over 20 years my wins have vastly out numbered my mistakes. Which is good as I’m only a few years away from retirement

#13 Doug Rowat on 09.21.19 at 3:59 pm

#11 Tannhäuser Gatekeeper on 09.21.19 at 2:53 pm

The road to perdition is paved with correlation matrices.

For the amateurs and the long-only buy side, they are the pivot point where the Prime question becomes not “is this a good investment,” but “how does it correlate with my current portfolio.”

For the PMs and the pros, “how much moar leverage does the VaR model say I can use.” … notwithstanding that the entire edifice of models is build on an assumption of Gaussian distributions of returns. Which, yeah, everyone knows is false, but it makes the models tractable.

Quite a mouthful. You might have spilled some Grey Poupon on your monocle getting all that out.

–Doug

#14 Joseph R. on 09.21.19 at 4:17 pm

#67 S.Bby on 09.21.19 at 11:42 am
The blackface scandal is quickly dying down as the left is giving Trudope a pass on this one because he is one of them. If this was Andrew Sheer or anyone else to the right side we’d be hearing of the outrage for weeks on end.

“It’s one thing to say that your portfolio is balanced and diversified, but it’s something else entirely to prove it.
The “scandal” hasn’t been out for a week yet. How do you know it’s not going to last weeks? What makes so certain Conservatives editorialists are not going to bring up every time they can?”

As far as I know, you are using equities sold on the stock market to build equities. You must also know the Stock Market is the secondary market for equities; you can only buy and sell to fellow investors, not corporations. The stock market represents only 10% of the “economy”. The bond market is 5X to size of the equity stock market.
So, in reality, you diversify yourself inside that 10% box.

A “businessman president” would know that and would not use high stock market numbers to say the economy is doing great: he would pay attention to the 90% instead. But that’s another discussion.

Do you buy in the primary market, like a private equity firm or hedge funds?

Also, do you touch the commodity markets?

#15 Doug Rowat on 09.21.19 at 4:18 pm

#2 leebow on 09.21.19 at 1:19 pm

Your trading strategy may introduce way more risk and volatility than you can diversify away using this type of analysis. If you panic sell, all prior analysis will prove useless.

The purpose of introducing low-to-negatively correlated securities is to reduce panic selling. But, yes, if someone is going to panic sell regardless then such securities won’t make a difference.

You seem to be saying that there’s no point in wearing a seatbelt if you’re going to drive your car over a cliff.

Correct, but this doesn’t mean that we should do away with seatbelts.

–Doug

#16 Camille on 09.21.19 at 4:38 pm

I like it! Thank you. I’m waiting for you to pull out your hidden Markov models?

#17 leebow on 09.21.19 at 4:52 pm

#15 Doug Rowat

I agree. Still need the seatbelt to ensure the viewing goes smoothly.

It’s a necessary tool, definitely. I was writing more for DIY investors. What I wanted to say is that it’s only one analytic that needs to be complemented by stress analysis and other methods. And gotta be prepared for eventualities.

#18 Its the hypocrisy on 09.21.19 at 5:16 pm

#5 conan on 09.21.19 at 2:18 pm
“The blackface scandal is quickly dying down . ”

Not surprised as it does not pass the smell test.
We would have heard about this back in 2001, if anyone in attendance, was remotely offended.

Everyone they talk to, who was there, had no problems…
JT was an actor playing Disney’s Aladdin in a school play…..

Typical cons screaming like banshees about nothing.

Would I vote for the Great white shark because the life guard said a bad joke? No I would not and most of Canada is the same way, except for crazy Cons.

…..

It stinks to high heavens….. T2 now puts up as his Twitter avatar him engaging with a black dude….. wow do they take you libs to be a bunch of gullible fools.. what a total schmuck you both are

#19 Kelly on 09.21.19 at 5:32 pm

How do your models works when the repo market freezes solid?

Massive influx of cash being shoved into system to make traders trade. Rightfully, none of them trust their counterparts.

Ponzi scheme about to meet its maker.

#20 Sail Away on 09.21.19 at 5:55 pm

In my elementary school, kids would get in fights over whether Fords were better than Chevys.

Pretty similar to the insults between Liberals and Conservatives I see here.

Sort of surprising to have ten-year-old boys on this forum. Just sad if adults act this way.

#21 Flop... on 09.21.19 at 5:59 pm

Bad news is I’m broke.

Good news is that it’s only gonna cost me a hundred bucks to dress up as Justin Trudeau this Halloween…

M45BC

https://www.halloweencostumes.ca/aladdin-live-action-adult-genie-costume.html?mpid=220353&gclid=EAIaIQobChMInMj2l_Pi5AIVFqvsCh26rAG5EAQYASABEgLRLPD_BwE

#22 crossbordershopper on 09.21.19 at 7:02 pm

i still dont understand why advisors dont use derivatives to hedge, insure, offset, and leverage positions to suite a client.
its quite possible and done everyday by millions of people, but i find it kinda odd that advisors dont know or understand advance calculus.
they know how to skim a fee off their clients, sure 2019 has been good, 2018 was lousy its the ebb and flow of investing.
you can structure a portfolio that protects on the downside more than any diversified portfolio can, since these days everything is linked up all go up or down,
and leveraged returns with finite risk assessment.
im just saying,

#23 Tyler Durden on 09.21.19 at 7:05 pm

“There are plenty of websites or software programs that can assist with building a correlation matrix.”

Short of manually making one on excel, can you suggest some of those websites or software programs? Thanks for all that you do!

#24 reynolds531 on 09.21.19 at 7:19 pm

When I worked in a financial institution I was doing accounting for our cash collateral program. That was during the financial crisis, so the firm was very focused on risk in the program.

That experience has me very interested in what happened with repos in the us this week. Doug any comments you’d like to make….?

#25 Sail Away on 09.21.19 at 7:21 pm

#7 Not So New guy on 09.21.19 at 2:44 pm
For Ants:

One part boric acid (aka Borax. Very inexpensive and found in most grocery stores) to six parts sugar mixed in water.

The ants go mad for it and then they take it back to their colony which they feed to the queen. She is the source of your problem so you will kill them at their source. It costs pennies and works relatively quick.

——————————–

Carpenter ants are easy to control. The main difficulty for most people is that you must do it yourself with fresh baits nightly after dark. Exterminators and spraying are nearly useless for carpenter ants; you need baits laced with boric acid to kill the queen. Killing the supporting ants does nothing when the queen is laying hundreds of eggs each day. Identify the ant paths at night in the summer and plot your strategy. Ants may be industrious, but most of us are smarter.

Almost all nests in houses will be satellite nests, so get rid of those (see above) and stay vigilant!

#26 theoryAndPractice on 09.21.19 at 7:26 pm

https://www.portfoliovisualizer.com/asset-correlations

https://repository.usfca.edu/cgi/viewcontent.cgi?article=1006&context=fe

https://pdfs.semanticscholar.org/a782/557522510099d45c558b1b9f6ffb01f7b3d2.pdf

#27 tccontrarian on 09.21.19 at 7:29 pm

First off, I came across this little factoid:

We seem to be operating in ‘new’ economy where making a profit is … optional?!

“…you wake up on a Casper mattress, hail a Lyft to get to your desk at WeWork, use DoorDash to order lunch to the office, hail another Lyft home, and have Uber Eats bring you dinner, you have spent your entire day interacting with companies that will collectively lose nearly $13 billion this year. Most have never announced, and may never achieve, a profit.”

I think I’m going to be piling on some short positions over the next several days/weeks. I’m betting that only Governments can run deficits on consecutive years…and stay afloat (but they do the power to raise taxes to pay for it all). We have one here in Canada now, no?

On topic of today’s blog post –
Having exposure to non-correlated assets is generaly underestimated in importance. For me (a non-professional), I’m thinking that I can achieve similar ‘safety’ by a mix of long/short strategies as well. Precious metals are at times reversely correlated to major Indexes, as it seems to have been over the past couple years.

#28 Drill Baby Drill on 09.21.19 at 7:42 pm

Black Face Boy is Toast. Internationally when he meets with other leaders who happen to be black or brown or whatever shade they happen to be there will not be any respect shown nor given to our so called PM.
He is a fool.

#29 Ace Goodheart on 09.21.19 at 7:44 pm

So sitting under my pergola at the cottage sipping a Sawdust City cold one and enjoying Climate Change.

It was 28 degrees today. I went swimming. Took the dock out. Put in a new water system. Much better pressure. Showers are now not so much wondering when the drip of water coming out of the head will briefly become a geyser but more of just “ahhhhhh much better”. I like this new pump set up.

Our old boat sank in a storm. I was quite worried. What to do? The electronics will obviously be destroyed. The motor was under water. Confefe! There was no hope. How could we ever save it?

Well….it’s a carburrated V6. With a thunderbolt electronic spark box. And a distributer. With a coil. So we drained ten quarts of water out of the oil pan, pulled the plugs and sprayed sea foam in the cylinders. Then we pulled the valve covers and did the same. Changed oil and filter, put it all back together and turned the key.

What happened? It roared to life, of course. What else could it do?

Deprived of a complex computer operating system that, drowned, would have rendered it an expensive piece of fish habitat, it started right up. Runs like a dream. Planes right out and has more power than it used to.

The unstoppable 1980s technology.

Even Climate Change can’t kill it.

#30 Tim on 09.21.19 at 7:46 pm

A good challenge, Doug, to do this for every holding in my portfolio to every other holding to make a matrix like the above. Thanks for drawing attention to this.

For others, the Excel CORREL() function will calculate the correlation (-1 to 1) between any two sets of numbers as long as there are the same number of data points in each set.

#31 Sail Away on 09.21.19 at 7:57 pm

#26 tccontrarian on 09.21.19 at 7:29 pm

———————————–

Sure, short all you want. Just remember that shorting is timing and markets can stay irrational longer than you can stay solvent.

How accurate is your crystal ball?

#32 Ace Goodheart on 09.21.19 at 8:02 pm

Sorry, “Covfefe”

#33 Bytor the Snow Dog on 09.21.19 at 8:08 pm

Paint dry? Did someone say paint dry?

Not you Doug. Conan’s post.

#34 Ace Goodheart on 09.21.19 at 8:13 pm

#25 Sail Away: just finished dealing with a carpenter ant problem at the cottage.

We initially called in the exterminators. They sprayed. The ants remained. They attempted to engage us in a discussion of ant habits and why we were still seeing them after they said they got rid of them. We realized we were on our own.

So we found the nests.

Two big ones. In the attic, of all places. We attacked. Ripped out insulation and vapour barriers. Found the Queens and killed both. A healthy dose of Canadian Tire ant, roach and insect spray did the trick. We revisited in a month to confirm we had decimated both colonies. No stragglers. Re installed vapour barriers and insulation.

Have not seen an ant since. Not a one.

Sometimes you just have to do it yourself.

#35 Scott on 09.21.19 at 8:27 pm

Not sure if I’ve ever heard a positive on this blog about cannabis investors but I don’t think even Garth would argue with the fact that daily +/-10% swings (more – than + lately) builds good experience in learning not to emotionally react. Being a younger investor I haven’t been through a recession yet but seeing my portfolio chopped in half in a month (twice so far) is a similar test. I’m worried that I’m conditioned to not be alarmed by massive drops and could sit on it all the way to 0. Oh well I still feel the same way that if even one company becomes half as much of a giant as future demand will require then the rest can go to zero for all I care. I think each side of the aisle in the US has positioned themselves to come out ahead so big moves could be coming shortly. If not maybe we’ll have to wait another year or 3 before a new (or current) POTUS or Congress decide to make it happen.

Thanks for the post Doug!

#36 Yukon Elvis on 09.21.19 at 8:33 pm

COPENHAGEN, Sept 20 (Reuters) – Jyske Bank said on Friday people with more than $111,100 in their bank accounts will be charged more for their deposits as it seeks to pass on some of the costs of recent rate cuts by the European and Danish central bank.

Jyske Bank, Denmark’s second-largest bank, said it would introduce a negative interest rate of 0.75% for all corporate deposits and for private clients depositing more than 750,000 Danish crowns ($111,100) from Dec 1.

#37 Nonplused on 09.21.19 at 8:34 pm

#13 Doug Rowat

What does Grey Poupon have to do with #11 Tannhäuser Gatekeeper’s comment?

I think he makes a very good point although not very clearly. I spent most of my career right in the middle of the risk management department of a couple of trading firms. I learned several things from this experience:

1. Risk management is important. Firms that do it last longer than firms that don’t.

2. Risk management that involves reducing exposure by trading with well capitalized entities (so, something like forward selling an open production position) works better than finding negatively correlated positions.

3. The models are important. They give you an idea how far out your arse is hanging.

4. The models are bunk. They are based on the idea that tomorrow can be accurately forecast (at least the range of outcomes) based on what happened in the past. When the SHTF all those correlations and volatility calculations mean nothing.

It’s a bit like forecasting the weather using only statistics. Yes, tomorrow’s weather can be more or less predicted by today’s weather (today and tomorrow have a high correlation in the weather world). But when the front comes in and you should have brought an umbrella the correlation with yesterday means nothing. You need satellites for that.

So as useful as the models are, human judgement from an experienced risk management practitioner added to the models is always better.

I’ve seen the market for natural gas go “no bid”, which was terrifying because we had gas on the pipe we had to sell. I’ve also seen that same market go “no offer”, which was also terrifying because we needed gas. The standard risk models do not predict such outcomes. Luckily we had, based on “human judgement’, limited our total volumetric exposure before hand rather than just relying on a VaR number.

I have an interesting experience from the California energy crises of 2000 (I think it was 2000). Our company had just brought the Wild Goose natural gas storage facility into operation, but we couldn’t sell any contracts because Enron was manipulating the market such that summer prices were substantially higher than forward winter prices. They (Enron and their co-conspirators) actually convinced the other storage operators to withdraw in the summer in exchange for firm delivery but indexed priced forward contracts. What could go wrong? Well, we were big on fundamentals and concluded that California was not going to have enough gas the following winter, so we filled up our storage facility with a very negative mark to market. We practically paid for the facility in one year once the SHTF. The VaR models said nothing about it. They were predicting a big loss with virtually no chance of a profit.

Things got so bad that other companies wouldn’t sell to PG&E because their credit departments said they didn’t think they would get paid. Our management took the stance that we needed to keep a good working relationship with PG&E, so we were going to sell to them at the market price even if we might not recover all of the agreed sales price. We got paid. A lot. But in our defense if we had not gone into that winter stocked up to the brim with gas that we had to mark at a terrible loss until the SHTF, things would have been a lot worse in California and we would have made no money at all. This is an example of the sorts of things a VaR model can’t tell you. Enron “painted the tape” so well and for so long it was impossible to tell from the models what they had in store for California, but we smelled a rat and traded against it. I got a free ski jacket and a big bonus, as did the whole team. I still have the jacket but spent the bonus.

Similarly, we profited handsomely from the Amaranth scandal. For those of you who don’t know what that was, a certain rock star trader took a relatively small amount of money (about a billion) and managed to drive the summer winter spread to never seen before heights. But they didn’t realize it was in fact their own trades that were creating the market and also resulting in the M2M just getting better and better and the VaR lower and lower. They were, through their actions, marking everyone’s books. We smelled a rat (but didn’t know at the time who the rat was), rode the wave up, and then sold everything we could at fixed price. Made a ton of money. Like a ton. A pallet of 1,000 dollar bills. Another big bonus which I also spent.

So models are great, and I was the chief modeler, but there comes a time when you have to defer to the traders and just tell management what it looks like the downside might be. If that risk is acceptable, sometimes you have to swing for the fence.

This is also why the next few years will be a good time to go long Alberta (oil and gas), no rush. Oil and gas will not go out of style no matter what AOC is saying, and it can’t go much lower. Buy companies that can weather the storm (i.e. have good balance sheets even at these low prices) and wait. It should be at least a 2 bagger.

#38 Sail Away on 09.21.19 at 8:38 pm

#34 Ace Goodheart on 09.21.19 at 8:13 pm

——————————-

#25 Sail Away: just finished dealing with a carpenter ant problem at the cottage.

Sometimes you just have to do it yourself.

——————————

Haha- yes, and likewise. I might open an ant extermination business and train the specialists to talk, write invoices, and then become unreachable. No equipment needed, and similar results. Good margins!

#39 crowdedelevatorfartz on 09.21.19 at 8:59 pm

Why can nobody spell “Scheer”? – Garth

+++++++
Because he’s about as memorable as “Joe Who’?

#40 Ace Goodheart on 09.21.19 at 9:13 pm

I used to have this little digital camera. It had a “night setting” mode. If you set it up on a firm surface, pressed the “night” picture selection button and then waited, it would take these incredible night pictures. The idea was you had to keep it steady in one place.

I met a guy who had lived his whole life in my neighbourhood. Mentioned a street I had looked at houses on, before deciding on our street.

His face was stone. No expression.

On further inquiry I learned that the group of boys that he ran with in his youth would not walk on that street, due to an ongoing quarrel they had with a group of young men who lived there.

Even today, forty years later, at the age of 67, he would not walk on that street. He said it made his heart beat too fast and his legs got pins and needles.

He needed his sense of place. Could not function without it.

As I drove down the forbidden street I thought about his conundrum.

And I realized that he was more free than I was.

He knew his fears. He had come to terms with them long ago. Had the discussion with himself as to what he.could and could not do and had drawn a conclusion.

I, on the other hand, just wandered.

Missing every important thing. Connected to nothing.

He could explain his steps in his life.

I could not.

The sharper picture….

#41 Doug Rowat on 09.21.19 at 9:16 pm

#23 Tyler Durden on 09.21.19 at 7:05 pm

“There are plenty of websites or software programs that can assist with building a correlation matrix.”

Short of manually making one on excel, can you suggest some of those websites or software programs? Thanks for all that you do!

—-

I might have tipped my hand with the source of my charts… Vanguard’s a good place to start.

—Doug

#42 Ponzius Pilatus on 09.21.19 at 10:19 pm

My pizza is always well balanced with Canadian back bacon and American pine apples.
Sleep like a baby.

#43 Sail Away on 09.21.19 at 10:21 pm

#40 Ace Goodheart on 09.21.19 at 9:13 pm

I met a guy who had lived his whole life in my neighbourhood. Mentioned a street I had looked at houses on, before deciding on our street.

His face was stone. No expression.

Even today, forty years later, at the age of 67, he would not walk on that street. He said it made his heart beat too fast and his legs got pins and needles.

And I realized that he was more free than I was.

He knew his fears. He had come to terms with them long ago.

I, on the other hand, just wandered.

—————————————

No need to ascribe anything deep and meaningful to his fear- it’s nothing more than an animal’s instinctual fear of a place they were hurt.

Most people can rationalize their way past this.

My bird dog refuses to go near a barbed wire fence that shredded his ear 6 years ago.

#44 Rargary on 09.21.19 at 11:02 pm

There goes my amateur BMO investorline confidence

#45 Grave digger on 09.22.19 at 5:38 am

Simple answer there mate. Buy good stocks that pay solid dividends monthly, quarterly, semi annually and annually, let the steady cash flow aquire additional shares.

Trading junior mining shares is a day traders job, settled at the end of every session. If you’re not Level Two access you aren’t a day trader.

Look at the amazing performance of our TSX darlings the past five years, not the past six months, brilliant. Doubles, triples and better. Shooting fish in a barrel really. I own shares in 50 such companies, 92.6% have doubled and more.

Looking at the past never made anyone a dime. BTW, not considering selling anything. The best is yet to come. Fundamentals are better than I’ve seen in a lifetime.

#46 theoryAndPractice on 09.22.19 at 8:28 am

Doug, Thanks for the post !

It is pretty easy to see which portfolio is better diversified above, in the given example.

But when it was not that clear ie both are having <<1 and <0 correlations. How do you evaluate the optimally diversified one?

#47 Dharma Bum on 09.22.19 at 9:30 am

Correlation, shmorrelation.

Just go with your gut!

Wu Wei, baby.

#48 Tannhäuser Gatekeeper on 09.22.19 at 9:58 am

I’ll try to explain my thoughts in a different way, now that I’ve fished my monocle out of the mustard pot.

Most days, correlation matrices don’t matter. The markets move a bit, your portfolio moves a bit. But the days that it matters are the days the correlations break down. That isn’t an accident. You print out pretty much the same correlation matrix for every one of your clients, and everybody else in the markets is looking at those same correlations, everywhere around the world.

Every crackup since computers became relatively cheap has been because large (often leveraged) sums were bet on correlations holding. When investigators arrived at the scene, the dead trader was always found clutching an out-of-date correlation matrix.

– 1987’s portfolio insurance blowup was based on the theory that if your cash portfolio in New York fell a bit, you could sell futures in Chicago to offset the loss, with no side effects. That trade turned reflexive.
– Long Term Capital Management was built on the theory of correlations holding. When one correlation broke, it blew up the fund, which in turn broke a lot of other correlations.
– Bear Stearns and Lehman Bros. (and AIG, and Deutsche Bank) were all about the correlations. How do you run a bank levered 20:1? With racks of computers that run correlations and monte carlo simulations all night, five nights a week.
– Eric Sprott blew up his Sprott Absolute Return Income Fund on a short vol bet — that the correlation between the Euro and the Swiss Franc would continue to hold. Shorting vol in something marketed as a low volatility income fund is a classic. Sprott got the income, his customers got the volatility.

The real money is made by looking at a correlation matrix and figuring out which correlation will crack.

The next bust is never like recent ones, because of institutional memory. But the markets are never the same either. Canadian banks won’t blow up like US ones did — they’ve offloaded crap borrowers onto non-bank lenders. But what else has changed since 2008? Defined benefit pension funds are a smaller part of the market, both because of the decline in DB and because they’ve diversified into PE, real estate and international holdings. Indexed funds have grown larger, and they won’t be a source of liquidity in a crisis. Risk parody funds have grown a lot, and they’ll be selling stocks AND bonds. Guaranteed interesting times.

Just my thoughts, from the backseat of the Rolls-Royce.

#49 Jesse on 09.22.19 at 11:35 am

Is there any literature I can be referred, that explains the inner workings and constructions of these matrices?

How do you come up with the ranking? And who?

#50 Gravy Train on 09.22.19 at 12:12 pm

#48 Tannhäuser Gatekeeper on 09.22.19 at 9:58 am
“[…] Risk parody [sic] funds have grown a lot, and they’ll be selling stocks AND bonds.”

Did you mean to write risk parity? Or were you making a joke?
https://en.m.wikipedia.org/wiki/Risk_parity

On an unrelated topic, you must be devastated at the death a couple months ago of Rutger Hauer, who portrayed the replicant Roy Batty (who “watched C-beams glitter in the dark near the Tannhäuser Gate”).
https://en.m.wikipedia.org/wiki/Tears_in_rain_monologue

#51 joblo on 09.22.19 at 12:13 pm

Here ya go hurtin Albertans, screw T2 and pathetic policies: (now if ya could just sell the house)

https://ca.finance.yahoo.com/news/were-ready-them-texans-see-140005369.html

#52 Doug Rowat on 09.22.19 at 1:14 pm

#49 Jesse on 09.22.19 at 11:35 am

Is there any literature I can be referred, that explains the inner workings and constructions of these matrices?

How do you come up with the ranking? And who?

—-

It’s not a ranking, it’s a relationship between historical price direction.

Start slow—Investopedia’s as good a place as any.

—Doug

#53 baloney Sandwitch on 09.22.19 at 1:23 pm

What happened to the brown dog?

#54 Tannhäuser Gatekeeper on 09.22.19 at 1:26 pm

“Or were you making a joke?”

Yes, t’was a joke.

I can understand how risk parity could work for a small fund, but once the concept is behind investments totalling $100b+, I have trouble seeing how it wouldn’t be reflexive — increased volatility in stocks and credits begets selling both, which reduces prices and further increases volatility in both… Who’s the natural buyer sitting on a pile of cash right now waiting for lower prices in both? Or who’s short both and would lever up as positions in both moved in their favour? Yeah, nobody.

But Ray Dalio seems smarter AND harder working than your humble correspondent, and he’s got lots of smart, hard working associates. I have only my chauffeur, so my analysis may not cut the mustard.

#55 Bdwy on 09.22.19 at 3:32 pm

Fantastic stuff here today.
Some dang smart doggies in the pound, prob border collies wearing monocles.

Thx to gt and the pack.

#56 bdwy on 09.22.19 at 3:49 pm

The unstoppable 1980s technology.

Even Climate Change can’t kill it.
—————-
nice!

but don’t try this in salt water…

#57 not so liquid in calgary on 09.22.19 at 7:52 pm

@ #67 S.Bby on 09.21.19 at 11:42 am

=========================================

The blackface scandal is not dying down. As a matter of fact, our PM is now the laughingstock of the world. As Mr. Turner recently told us, “I know a Kim Campbell moment… “.

#58 Jesse on 09.23.19 at 9:35 am

#52

Thanks Doug