SURVIVAL of the FITTEST for INVESTORS USING DARWIN’S LAWS of EVOLUTION to BUILD a WINNING PORTFOLIO DICK STOKEN Copyright © 2012 by Dick Stoken All rights reserved Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher ISBN: 978-0-07-178229-6 MHID: 0-07-178229-X The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-178228-9, MHID: 0-07-178228-1 All trademarks are trademarks of their respective owners Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark Where such designations appear in this book, they have been printed with initial caps McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs To contact a representative please e-mail us at bulksales@mcgraw-hill.com This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional service If legal advice or other expert assistance is required, the services of a competent professional person should be sought —From a Declaration of Principles Jointly Adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations TERMS OF USE This is a copyrighted work and The McGraw-Hill Companies, Inc (“McGraw-Hill”) and its licensors reserve all rights in and to the work Use of this work is subject to these terms Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior consent You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited Your right to use the work may be terminated if you fail to comply with these terms THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE McGraw-Hill and its licensors not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom McGraw-Hill has no responsibility for the content of any information accessed through the work Under no circumstances shall McGrawHill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise To my grandparents, Benjamin Stoken, Ester Kite, Betty Twersky, and Harry Ogens, who crossed an ocean and settled in an alien culture to provide their descendants the promise of a better life I hope the book is worthy of you CONTENTS ACKNOWLEDGMENTS PREFACE PART THE ORIGIN OF A NEW INVESTMENT STRATEGY CHAPTER The Investment Game CHAPTER The Investment Environment: An Ever Changing Landscape CHAPTER The Darwinian Alternative Framework CHAPTER The Stock Market Is a Living System PART VARIATION: THE FIRST IMPORTANT DARWINIAN INSIGHT CHAPTER An Alternative Investment Portfolio: Based on Variation CHAPTER A Passive Combined Asset Strategy PART FLUCTUATIONS: THE KEY TO UNDERSTANDING COMPLEX ADAPTIVE SYSTEMS CHAPTER Trends: The Central Feature of Our Investment and Economic World CHAPTER A Paradox in Our Investment and Economic World PART SELECTING ASSET CLASS “FITS” CHAPTER Critical Levels in the Stock Market CHAPTER 10 Gold and Long-Term Treasuries: Buy and Replace CHAPTER 11 REIT Estate Investment Trust Trends CHAPTER 12 An Active Combined Asset Strategy CHAPTER 13 Risk: Taking On More? CHAPTER 14 The Twenty-first Century “Real Estate” Bubble PART A DARWINIAN WORLD CHAPTER 15 The Agent Role in a Darwinian World CHAPTER 16 How the Major Components of Search Engines Apply in Today’s World 209 CHAPTER 17 Conclusion: Don’t Sell Evolution Short NOTES INDEX ACKNOWLEDGMENTS Thanks to: Larry Bernstein, Kingsley Stoken, and Deidre Stoken McClurg, for patiently reading my manuscript and offering many helpful suggestions You made it a better book than it would have been Joel Weisman, my agent and critic of the first part of the manuscript, for pointing me in the right direction Robin Kramer, my faithful assistant, who was always willing and able to perform the numerous chores necessary to bring this project to completion Gary Crossland, for providing many of the statistical calculations used in this book Michael McClurg, who diligently assisted Deidre with the graphics which enhanced the book Finally to the lovely “Sandra Loebe-Stoken,” who gets the award for putting up with a mate totally absorbed in his project The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one The commonest kind of trouble is that it is nearly reasonable, but not quite Life is not an illogicality; yet it is a trap for logicians It looks just a little bit more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait —G K Chesterton P REFACE After graduating from the University of Chicago, School of Business, some 50-years ago, I felt, oh, so smart I thought I had become a member of a small elite group who really understood our world and had acquired intellectual tools to be successful in whatever I chose to In my case, it was to be a trader I found an excellent opportunity at the Chicago Mercantile Exchange, where for a nominal sum of money I could purchase a membership and trade directly on the floor I would be able to use my trading skills to beat the heck out of the market, in that case, a commodities market Well, it wasn’t as easy as I expected Soon I recognized that all of my previous education was utterly useless in trying to outsmart a “smart” market I realized that to survive and prosper in the rough-and-tumble environment of a marketplace, I would have to unlearn most everything that I had so painstakingly acquired … and discover skills more attuned to dealing with an uncertain future In this venture, I was completely on my own, as there were no teachers or blueprints to follow Bit by bit, by trial and error, as I knew of no other way, I learned how a market worked, with its own peculiar logic—and how to master it Without realizing it at the time, I had acquired a unique conceptual framework of how the world worked—opening the door to insights into other social areas, such as politics—that was quite different from the Newtonian logical, cause-and-effect construct that had been embedded into my brain from grammar school up through a prestigious graduate university I became successful enough so that I was able to retire, at the ripe old age of 31, and self-finance new endeavors Yet when I tried to communicate what I had learned to others, outside of a few peers at the commodities exchange, I would only elicit glazed eyes or blank stares You see the language for my new conceptual framework was in my head only, and I lacked a proper vocabulary to articulate it Even most of my peers were only interested in my conclusions: Is the market headed higher or lower? In many ways I felt like a lost soul, able only to communicate about mundane things When talking about more heady matters, I struggled to frame my ideas in a watered-down Newtonian vernacular It was terribly unsatisfying, as most of the time I was not able to relay to others what I really thought Only a few years ago, I discovered the existence of a new science While browsing a London bookstore I picked up a book, The Origin of Wealth, by Eric D Beinhocker.1 I started reading it immediately, and my unarticulated ideas bubbled to the surface I read through the night and into the next Finally I had found a home for those long-buried notions; I had found a language and an organizational structure through which they could be expressed The concept that so tantalized me is called “complex adaptive systems (CAS)”: it is a new science that is just now beginning to emerge Actually, it is more than just a new science Like the Newtonian “intellectual” revolution, this idea has the potential to become a new mental construct, as Beinhocker states, “the prism through which we conceptually view our universe.” CAS, in part a critique on the Newtonian mental construct vigorously publicized by Mr Beinhocker, is still in its embryonic form Though the world has not yet taken much notice of the concept, take heed, as it is showing signs of intellectual vigor In the mid–1980s, a school in Santa Fe, New Mexico, called the Santa Fe Institute, was founded to study this new science New curriculums in complex adaptive systems have already been established at several leading universities, including the University of Michigan, the University of Virginia, and Northwestern University In its simplified form, CAS proponents maintain that the Newtonian worldview, which so captivated Western societies after Sir Isaac Newton’s seminal discoveries about the motion of heavenly bodies, had hit a brick wall CAS people readily concede that the Newtonian logical “cause-and-effect” construct played an immense role in propelling Western societies to the forefront of modernity It enabled us to create precision machinery of all kinds, from trains to planes; it provided a foundation that led to the building of rocket ships capable of taking man to the moon; and it laid the groundwork for our enormous strides in beating back and, in some cases, defeating disease However, because of that very success we thought it could also be the vehicle to master other areas, such as economics and investing But in those endeavors, the Newtonian construct has proven to be a dismal failure—one has only to survey the carnage from the financial crisis of the late 2000s that our economic leaders told us could not happen However, repetitive errors didn’t stop us After each blunder we kept thinking we were just one repair job away from mastering those areas, as we had with the hard sciences In a nutshell, the Newtonian construct has allowed mankind to acquire a knowledge of linear, cause-and-effect relationships and use them to create mechanical entities, wherein all the interacting parts could be programmed to act in preset ways so that outcomes were highly predictable, for example, airplane accidents are few and far between and the rare mishaps that occur are identified and fixed so as not to be repeated As long as the parts to a system are inanimate, this approach works remarkably well But when the components of a system are humans, as they are in the stock market and the economy, or say a political system, this approach breaks down This happens because humans are intelligent; they learn, they adapt … and they cannot be programmed or directed to act in a specific way that will produce a reliable outcome Complex adaptive systems built around humans must be approached in a different manner They are, as their name implies, complex The large numbers of components that make up the system interact in a non-simple way There are too many connections to properly understand all of the relationships, which are also continually shifting And the models the experts build in trying to grasp and analyze these connections are imperfect, and inevitably break down To understand these systems, we must look for a window to peek inside And that window is the self-regulating fluctuations, which occur in a trend-like manner That is what this book is about: understanding the trends which are the basic mechanisms that underlie stock market movements In this book, I will teach you how the stock market works and introduce an algorithm, based on these concepts, that has outperformed the stock market on both the return and, even more importantly, the risk side for almost a hundred years I will take you on a journey to places conventional financial professionals have not yet visited, to see things you haven’t seen before By the time you emerge at the finish line you will have an entirely different and postmodern way of viewing the stock market—a new investment cosmology Come with me on this journey Free play, 30 Friedman, Milton, 103 From, Al, 34 FTSE, 64 Fundamental analysis, 84–86 Gain-to-pain (G/P) ratio, 17, 20, 230 of ACA portfolio, 154 of AIP, 62, 66 of ART strategy, 149 of B&H portfolio, 128 of B&S method, 128, 129 of intermediate government bond, 22, 23 of L:ACA portfolio, 168 of S&P 500, 62 GDP See Gross domestic product Germany, 198 Global economy, 40 Global warming, 211 Gold, 7–8 in ACA portfolio, 157–158 in AIP, 58–69 in B&R strategy, 132–142 in G/T portfolio, 70–71 history of, 55–56 inflation’s impact on, 54, 131 investment potential of, 71–72 long-term Treasuries’ relationship to, 132–133 NAV of, 135, 136 in PCA portfolio, 73–75, 78–80 Gold and Treasury (G/T) passive portfolio, 70–71, 132 compared to B&R strategy, 139–140 Good tricks, 28–30 Gore, Al, 32–34 Gould, Stephen Jay, 37 Government deficit, G/P ratio See Gain-to-pain ratio Great Depression, 9, 32, 103 See also Depression gold during, 55 Great Recession, 224 Greed, 27–28, 109, 195 Green Revolution, 212 Greenspan, Alan, 97–98, 99, 105, 213 Gross domestic product (GDP), 211 G/T passive portfolio See Gold and Treasury passive portfolio Gullible participants, 96, 100, 216 Hindsight bias, 198 Hitler, Adolf, 198 Home equity, 190–191 Home-owners, 190–191 Hoover, Herbert, 103–104, 198, 201 Housing See Real estate Hulbert, Mark, ICF See Exchange-traded funds Industrial Revolution, 38, 117, 210 Inflation, 211, 212, 229 from 1913-2010, 53–55 B&R strategy related to, 132 downtrends in, 54, 56 gold related to, 54, 131 intermediate government bonds related to, 56 long-term Treasuries related to, 54, 56 real estate related to, 181–182 REITs related to, 54 stocks related to, 54 in TIPS, 230 uptrends in, 54 Information democracy of, 86 limitations of, 203, 205–206, 231–232 relevancy of, 84–86 revolution of, 210 Interactive Brokers, 162, 171 Interest rates, 105 Intermediate government bonds, 20 in B&S method, 117 G/P ratio of, 22, 23 inflation, long-term Treasuries and, 56 performance of, in out-of-market period, 121–123 return statistics from 1926-2010, 11–19 Internet, 98 Investment strategy, 225 innovation in, 226 variation as, 47–48 Invisible hand, 27–28, 34–35 Iron law of living systems, 108–110 Japan bubble of 1980’s in, 217–218 business model of, economy in, 7–9, 32, 99 real estate in, 183 J.P Morgan, Kazantzakis, Nikos, 110 Keynes, John Maynard, 84–86, 182 Keynesian convention, 88, 96 Knowledge, arrogance and, 203–205 limitations of, 203, 205–206, 231–232 L:ACA portfolio See Leveraged active combined asset portfolio L:AIP See Leveraged alternative investment portfolio The Last Temptation of Christ (Kazantzakis), 110 Latin America, 211, 212 Legg Mason Value Trust Fund, 5, Lehman Brothers, 97, 106, 107, 158 real estate market’s relationship to, 185 Leslie Orgel’s Second Rule, 29, 35 Leverage at 2.5:1 ratio, 184–186, 187, 189 at 5:1 ratio, 183–186, 187–189 in ACA portfolio, 164–165 added to AIP portfolio, 163–164 AU related to, 163–164, 175 defined, 162 drift, 164–165, 190 in ETFs, 174–175 in L:ACA portfolio, 165–168, 170–171 in L:AIP portfolio, 173–174 in L:PCA portfolio, 171–172, 174 in PCA portfolio, 163–164 in real estate, 179–192 selecting proper amount of, 162–164 in S&P 500, 163–164, 168–170 in T-Bills, 162–163 Leveraged active combined asset (L:ACA) portfolio AU of, 168, 170–171 Berkshire Hathaway’s performance compared to, 168 G/P ratio of, 168 performance of, 165–168 success of, 170–171 Leveraged alternative investment (L:AIP) portfolio, 173–174 Leveraged passive combined asset (L:PCA) portfolio, 171–172, 174 Leveraged speculators, 150 Limits to Growth, 211 Liquidity, 131, 136, 230 Living system, 25–26 American Dream, 190, 199–200 animating narrative in, 210, 212, 216, 229 anticipatory narrative in, 210–212 behavioral patterns related to, 209, 210 error-prone agents, 212–213 errors in, 212–213, 214–215 extinction of, 39–41, 224–225, 231–232 fluctuation in, 201, 214–215 free market as, 30–32, 40 Iron law of, 108–110 narrative of, 199–201 natural selection in, 28–30, 113, 230–231 political leader’s role in, 199–200, 220–221 punctuated equilibrium in, 32, 37–38, 227–228 religion in, 196, 199 risk misperceptions in, 213–214 risk of ruin in, 41–43, 47, 175–177 self-organization in, 26–28, 89, 209, 231 stasis in, 37–39, 227–228 trends in, 209–210 wealth’s role in, 199–200 Lo, Andrew, 24 London Bullion Market, 55–56 L:PCA portfolio See Leveraged passive combined asset portfolio Marginalization, 96–97 Market index price, 216 Mathematics, 97 Matthews, Herbert, 204, 205 McDonald, Lawrence, 97 Media, Miller, Bill, 5–6, 96 Millerites, 196 Mondale, Walter, 8–9 Money from 1913-2010, 48–52 dollar, U.S., 55 rate of change in, 48–52 value of, 53–55 Money magazine, 5–6 Montgomery Ward, Morgan, John Pierpont (J.P.), Morgan Stanley Capital International Index of Developed Stock Markets (MSCI), 66 Morgan Stanley Capital International Index of Emerging Markets (EEM), 66, 79 Morningstar, 5–6 Ibbotson ‘SBBI’ Classic Yearbook, 11, 127 Mortgage, 183–184, 190–191 MSCI See Morgan Stanley Capital International Index of Developed Stock Markets Muscular culture, 39–41 Mutual fund managers, 5–6 Nader, Ralph, 32–34 NAREIT See National Association of Real Estate Investment Trusts Nasdaq, 66 Nasdaq 100 Index (QQQ), 79 National Association of Real Estate Investment Trusts(NAREIT), 64 All-Equity REIT Index, 144 National Bureau of Economic Research, 224 Natural selection, 28–30, 113, 230–231 NAV See Net asset value NC/TY See Negative correlation to total years Negative cash flow, 184 Negative correlation, 57, 65–69, 223, 230 Negative correlation to total years (NC/TY), 65 Net asset value (NAV), 11–18, 21 of gold, 135 of gold combined with long-term Treasuries, 136 of long-term Treasuries, 136 Neuroscientists, 26 New York Stock Exchange (NYSE), New York Times, 203–205 Newton, Isaac, 4, 34, 226 Newtonian thought, 3–4, 10, 23, 25–26, 28 Newtonians, 34–35, 81, 202–203 and Cato’s snare, 103, 227 Nikkei 225, 217 1926, 11, 117 Nixon, Richard, 55 NYSE See New York Stock Exchange Oil, Operating expenses, 183–184 Optimism, 95, 110 Outcome bias, 198 Out-of-market periods intermediate government bonds during, 121–123 intermediate Treasury during, 145 REITs during, 145 S&P 500 during, 121–123 Pain threshold, 20 Panicking, 42–43 Paradox, of living systems, 108–111 Passive combined asset (PCA) portfolio asset division of, 73 gold in, 73–75, 78–80 leverage added to, 163–164 long-term Treasuries in, 73–75, 78–80 passive portfolio compared to, 75–76 performance of, 74–75, 78–80 positive to negative composition of four asset classes in, 79 REITs in, 73–75, 78–80 SB60/40 compared to, 76 S&P 500 in, 73–75, 78–80 S&P 500’s performance compared to, 76 variation in, 78–80 Passive portfolio of gold and long-term Treasury, 70–71, 132 PCA portfolio compared to, 75–76 risk profile of, 76 Payoff, 20 PCA portfolio See Passive combined asset portfolio Peaks, 53 Peak-trough falloffs, 21 Personal strategy, 202–203, 207 Point of entry, 120 Political leaders, 32–34, 198, 201–202, 204–205 See also specific leaders living system’s role for, 199–200, 220–221 Political upheaval, 42 Politics, 32–34, 198, 201–202, 204–205 Positive cash flow, 184 Positive components, 157 Positive to negative composition, 79 Pothole pain, 12–17 Potholes, 21, 23, 38, 42 in AIP, 69–72 in B&S method, 128 tendency to ignore, 83 Prestowitz, Clyde, Prey/predator model, 31 Prices upward trajectory of, 88 U.S history of, 1913-2010, 48–52 Profit-seeking pattern, 89, 104 Progression, 38 Property market See Real estate Prosperity, 9, 83–84, 105, 109 of 1920s, 201 following World War II, 143 Protection, from peril, 121 Psychic punishment, 96–97 Psychology, 195–196 Punctuated equilibrium, 30, 32, 37–38, 227–228 QQQ See Nasdaq 100 Raskob, John J., Rating service, for funds, 5–6 Rational choice, 26 Rationality, 195–196, 202–203, 207 Ratios See also specific types leverage, 2.5:1, 184–186, 187, 189 leverage, 5:1, 183–186, 187–189 offensive/defensive, 176–177 success, 121 Reagan, Ronald, 8–9 Real estate, 64 AU of, 181 bubble, 96–97, 100–102, 146–147, 149, 179–182, 213, 216, 219–220 bull market in, 182, 185 buying/occupying, 190–191 capital appreciation in, 182–183 credit’s role in, 100–102 DDs in, 183 dividends in, 182–183 inflation’s role in, 181–182 in Japan, 183 Lehman Brothers related to, 185 leverage related to, 179–192 leveraged speculators in, 150 post World War II, 143 stability in, 181–182 Real estate investment trusts (REITs) in AIP, 58–61, 64–69 in ART strategy, 144–150, 186–189 ART strategy compared to passive performance of, 147–149 inflation’s impact on, 54 during out-of-market periods, 145 in PCA portfolio, 73–75, 78–80 Real estate speculators, 179, 182 alternative 5:1 strategy for, 188–189 in early 2000s, 183–189 with leverage ratio of 2.5:1, 184–186, 187, 189 with leverage ratio of 5:1, 183–186, 187–189 Reason, 195–196 Reasonable calculation, 84–85 Reasoning skills, 195–196 Rebalance, 164–165, 176 Recession, 9, 32, 224 Reckless gambling, 102 Regulation T, 165 Regulators, 101, 106 Reinhardt, Carmen, 215 Reinvested dividends, 18 REITs See Real estate investment trusts Religion, 196, 199 Remission, 91 Republicans, 33, 201 Resiliency, 38–39, 41, 106–107 Resolution Trust Authority, 212–213 Returns See also Annual component return; Excess return of ACA portfolio, 154 of ART strategy, 147–150 of B&R strategy, 137–140 of B&S method, 123–128 increasing rate of, through combining portfolios, 68–69 risk related to, 19–20, 161, 223, 230 yearly statistics from 1926-2010, 11–19 Reuters, Thomson, 91 Rising trend, 83–84, 90 of real estate, 100–102, 144 role in bubble territory, 95–96 Risk, 4, 18, 110 analysis, 19–20 -avoiding behavior, 86, 91–92, 95, 108–109, 215, 219–220 behavior related to, 86–88, 213–214 in B&H portfolio, 42–43 in B&S method, 123, 128–130 calculation of, 97 control, 123, 130, 161–177 equity, 154, 156 mean risk, 19 measures, 17 misperceptions of, 213–214 perceptions of, 87–89, 90, 91, 95, 106–107, 191–192 profile, 22, 76, 153–154 reduction of, 21, 23 return related to, 19–20, 161, 223, 230 of ruin, 41–43, 47, 175–177 tail, 19 -taking behavior, 86, 88, 89–91, 95, 102, 108–109, 215 Rogoff, Kenneth, 215 Roosevelt, Franklin Delano, 55 Ruff, Howard, Russell 2000 Index, 66 Russia, 42 Savings, 106–107, 109 Savings and Loan (S&L) crisis, 211, 212–213 SB 60/40 See Stock/Bond 60/40 Search engine, 231 for asset class, 113, 140–142 B&R strategy as, 140–142 channel breakout method, 115–117 components of, 209–215 trends in, 209–210 Securitization, 97 Selection, 28–30, 113, 230–231 Self-organization, 26–28, 89, 209, 231 Sell signal, 224 for ART investors, 189 in B&S method, of DJIA, 119–121 object of, 121 Shadow banking systems, 100–101 Share prices, 9, 90, 102 Shiller, Robert, 179 Siegel, Jeremy, 18, 47, 111, 210, 225–226 Silver, 7–8 Simon, Herbert A., 195–196 S&L See Savings and Loan crisis Small stocks, 23 Smith, Adam, 27–28 Smith, Edgar Lawrence, 104, 183, 225–226 Smoot-Hawley Tariff Act, 104, 201 Social context, 26 Social harmony, 202–203 Social learning, 26 Socrates, 203 South America, 211, 212 S&P 500 See Standard & Poor’s 500 Spending habits, 90, 91, 100–101, 105, 107, 212, 220 public, 99 Spontaneous order, 27 Stability, 181–182 Standard & Poor’s (S&P) 500, 5–6, 8, 10, 226 1972-2010, 57 2009-2011, 57 ACA portfolio’s performance compared to, 154–158 AIP 50/50’s performance compared to, 76–78 AIP and, 45, 64–67 AIP’s performance compared to, 62–64, 69–72 B&R strategy’s performance compared to, 136–137 dodging bear market, 123 in double bubble, 218–220 forecasting of, after crisis of 2008, 91–92 as index, in B&S method, 117–118 leverage added to, 163–164, 168–170 long-term treasuries and, 56 measuring underperformance in, 19 in out-of-market periods, 121–123 in PCA portfolio, 73–75, 78–80 PCA portfolio’s performance compared to, 76 “Security Price Index Record,” 119 Standard deviation, 17, 19 of B&H portfolio, 128 of B&R strategy, 140 of B&S method, 128 Start-up companies, 30–31, 85–86 Stasis, 37–38, 227–228 Statistics investment value pertaining to, 84–86 of returns from 1926-2010, 11–19 of stock/bond market, 19–20 Stocks ER of, 17, 20 fitness of, 47 foreign, 23 inflation’s impact on, 54 return statistics on, 11–19 small, 23 Stock market capitalist economy related to, 27 critical levels in, 115–117 data of, 11 during dot-com bubble, 97–100, 216 history of, 11, 22–23 as living system, 37–43 plunge, 19 return statistics from 1926-2010, 11–19 Stock/Bond 60/40 (SB 60/40), 12–17, 21, 22 B&S method compared to, 129 PCA portfolio compared to, 76 Stocks as Long-Term Investments (Smith, E.), 183, 225 Stocks for the Long Run (Siegel), 18, 225 Success stories, in investment community, 88 Synchronization, 26 Tariff rates, 104 Taxes, 128 cuts in, 8–9, 99, 220 increases in, 103–104 T-Bills, 90-day, 20, 22–23, 117 from 1926-2010, 12–17 ACA portfolio compared to, 154–157 leverage and, 162–163 This Time is Different (Reinhardt, Rogoff), 215 Time CAS related to, 106 one year unit of, 116 periods of, 116–117 TIPS See Treasury inflation-protected securities Transaction costs, 128 Transmitter, 87, 89 Treasuries, intermediate, 113, 121 in ACA portfolio, 157–158 ART strategy compared to, 145–146 during out-of-market period, 145 Treasuries, long-term, 18, 131 in ACA portfolio, 157–158 in AIP, 58–69 AU of, 20 in B&R strategy, 132–142 gold related to, 132–133 in G/T portfolio, 70–71 inflation’s impact on, 54, 56 NAV of, 136 in PCA portfolio, 73–75, 78–80 Treasury inflation-protected securities (TIPS), 230 Trends bubble territory related to, 95–102, 216 bull, 118 in fluctuation of market, 83–84, 86–93 in living system, 209–210 methods of spotting, 130 recognizing changes in, 111, 229 rising, 83–84, 90, 95–96, 100–102, 144 in search engine, 209–210 tracking, using channel breakout method, 115–117 Trial and error, 29, 31, 90, 106, 207 Troughs, 53 Uncertainty, 84, 197, 202–203, 207, 231–232 belief’s role in, 214 Unemployment, 32 Uptrends, 54 Value, 84–86 of money, 53–55 Variation in ACA portfolio, 158–159 of asset classes, 73, 78–80 in evolution, 45, 47–48 as investment strategy, 47–48, 223, 230 in PCA portfolio, 78–80 Vicious cycle, 91–92 Virtuous cycle, 89–91 Volatility, 19, 32, 130 Volcker, Paul, 212 Vote, 220 Wages, 90 Water boarding, by investors, 21 Watermark, 21, 99 WDD See Worse drawdown Wealth destruction of, 108, 110 distribution, among classes, 102 -generating system, 38, 40, 41, 48, 64, 65, 83–84, 210–211 in living system, 199–200 map, 11, 18 pinnacle of, 39 Wealth-loss barrier, 175–176 Western business model, Westerners, 3–4 World War I, 27, 42, 201–202 World War II, 9, 100, 143, 198 Worse drawdown (WDD), 66 ... characterize the biological realm, rather than the sort of immutable laws that form the foundation of physics I am going to reach into Darwin’s grab bag of biological laws and create three portfolios by... critical point a few additional grains sprinkled on the pile may lead to a small or disproportionally large avalanche; think of the assassination of the Archduke Franz Ferdinand of Austria in... Strategies that use more leverage or higher betas (a measure of the volatility of the asset compared to the volatility of the financial market as a whole) are, indeed, likely to display higher standard