Jeremy Witbeck:
All right, welcome, everyone to our Polaris Podcast. So I’m Jeremy Witbeck, partner of Polaris Wealth Advisory Group. And we have Jeff Powell, our managing partner and chief investment officer on the line with us, Jeff, good to see you.

0:17
Good to see you as well, Jeremy.

Jeremy Witbeck:
So Jeff, we last week, when we met, we had a conversation about some of the terms that are used in the financial industry and recognizing that these are not terms that you often hear about. And we have a tendency to assume that everyone knows what they mean. And so, in the spirit of last week, I thought it’d be fun to continue to go through the different terms and really understand what they mean. We’re going to change up a little bit. Whereas last time we started on the more serious ones, we’re going to start with the fun ones, and then interweave the more serious terms as we go along. And so on that, let’s go ahead and start with one that you hear a lot about, and that is don’t like the tape. And not talking about wrapping Christmas presents either.

Jeff Powell:
Yeah, that was just said they’re definitely gonna be the tape could be taken in a lot of different ways. But don’t find the tape is a fun phrase. I mean, it’s a it’s a technical phrase, talking about the stock market. So if you think about back in the day, back before electronics, and so on, you had a ticker tape. And that’s whether you had ticker tape parades and everything else where it was the competitor that was thrown out the window, everything else. And so when you talk about not fighting the tape, that’s what they’re referring to is the ticker tape, and they’re talking about the markets moving up, you know, regardless of if you think it should be going up or not, why would you fight it? So it’s saying, hey, if the markets are moving up, technically, we fight it, don’t fight the tape, you know, if it’s going up or down, you can sit there and say, hey, there’s no rational reason for this market to be dropping, which again, last time, I can think of a market like that was the end of 2018, where the economy was great earnings were great. People started worrying about the potential of having a recession, and the markets dropped 20%. Not quite 20. Because enough, that would be Wi Fi to take no, didn’t look like it should be going on. But why would you fight the tape? It’s going down. So get out of the way of that, you know, the conversely, you could sit there and go, gosh, the valuations in the markets right now don’t make any sense. Which direction is the market heading? It’s pretty much going up. So why would you fight the tape? That’s what we’re talking about with it.

Jeremy Witbeck:
Yeah, and sometimes you’ll hear different versions of it, like the trend is your friend, or the market has inertia. But same concept where if the markets going against you, as much as you may feel like you’re right, the market movement against you means that you’re wrong, at least for that time. On a more serious note, what is r squared?

Jeff Powell:
r squared going back to math class again, so r squared is talking about how much of your portfolio performance is coming from market movement versus investment selection. So an R squared of one for example, would really mean that, that you were indexed that your your portfolio basically, is going to move up and down, it’s sort of the rising tide lifting all ships, but really, you’ve got a an index ship, rather than anything else. r squared of below that is really where you’re starting to see value being brought to the table by the investment selection. So again, you’re saying less than less of the price movement of your portfolio is driven by the underlying benchmark that you’re comparing yourself to. The issue with that is, you know, in some cases, some institutions actually want to see you have an R squared above point nine, because they want there to be less tracking error, as they call it. What we look at behind it is it’s not about tracking error, it’s about us being able to sit there and say, oh, by the way, given this current market environment, maybe you should held no financials. Or maybe you should hold no energy, or maybe you should hold, no whatever. And we’ll eliminate specific segments of the market, not invested in them at all, and then be very overweight in other areas of the market, that we feel like have the greatest amount of strength. So in doing that, you’re not going to look like an index. Our whole idea is the only way that you’re going to outperform a benchmark is by having some fortitude of what you believe is going to happen. And under an overweight specific segments of the marketplace, and specific holdings, in order to bring value to the table, which we were talking about last week talking about alpha is one of the ways that we’re able to bring alpha to the table is by shifting around the sectors that were willing to invest them.

Jeremy Witbeck:
Yeah, another really good explanation. I’ll tell you this is one of my pet peeves when it comes to the investment Unity is that we use r squared and we try to overuse it right. So for example, r squared can be helpful. So you can see kind of what index is the right one that you’re tracking around. But then we want to over utilize it and saying, Well, if your R squared deviates too much from the benchmark, then I’m going to penalize you. And 2020 is a great year, I don’t know of a single client that would have said, Hey, you only took on half the downside of the market when it fell, your R squared is 50. Or point five, I’m just satisfied with that, that would be an extreme example of what would be a homerun in our world. And yet r squared would sit there and say, well, that’s not a good thing. So to your point, tool, but like anything, when over utilized over relied upon, it can lead to bad conclusions. And unfortunately, I see that a lot, where we want to really just look at things at a glance and try to understand them. And it’s something that can mean something or it can mean something entirely different. And a lot of people don’t necessarily take the time to really understand the story that’s being painted with that. Another fun phrase, and that is don’t catch the falling knife, which is probably good advice in all regards. But what does it mean, when, when we’re talking about it and investments or financial scams?

Jeff Powell:
Well, I mean, again, if you just kind of think about the or visualize what that means, you’re sitting in your kitchen, and you’re cooking, and you knock a knife off the countertop, would you catch it? And you know, most people would say, no, they’re gonna let it hit the floor a lot, it’s subtle, and then they’ll pick up the knife, because it’s too dangerous to try to catch a knife that’s falling, because they’re gonna get caught murdered. Same is true with the stock market, if you’re looking at a stock, and you’re investing in it, just because the price looks cheaper than it was a week ago, two weeks ago, whatever, you’re catching, potentially a falling knife, have the fundamentals change what’s driving the factor of this stock, dropping in value, you really need to understand about the fundamentals and the technicals behind that. So we recommend highly to not only not let it, not try to catch it, let it settle for a while, we’re gonna, we’re gonna want to track different technical things in order to understand the bottoming out process, and then the recovery, and you don’t need to be the first one in the recovery. You just need to participate and a good portion of it. So we just really don’t like to be involved in stocks just because they appear to be cheaper. We want to be in great companies that are fundamentally sound that happened to provide us good value.

Jeremy Witbeck:
Yeah, absolutely. And now this is one of those lessons, I think a lot of people learned it the hard way in the market sell off that happened in Oh, wait, where a weight dropped, and then people bought in, and then it dropped some more. And then they bought in. And then there’s a dead cat bounce, and they bought it and then it dropped some more. And so to your point, right? If you’re looking at things and wanting to not get cut on the way down, you need to let it settle. And you need to see signals of strength before you you start taking advantage of some of the discounted pricing. Let’s go ahead and talk about some of the ratios that we use. And the first one is the Sharpe ratio. So what is the Sharpe ratio trying to tell us?

Jeff Powell:
Well, Sharpe ratio is again, going back and looking at risk adjusted performance, you’ve got several different ways of being able to look at it. So rather than getting too technical with it within this podcast in particular, the biggest thing that I would just throw out is estimating the Sharpe ratio is as a way of being able to say, Okay, what is the risk adjusted performance? Is it strong? Or is it not strong based upon its benchmark? So use it kind of like an alpha. You know, there are several other mechanisms of how to view the market and its risk levels and its valuation. So Sharpe ratio, again, another way of us being able to determine,

Jeremy Witbeck:
yeah, the one thing that I that I think it’s important to note about the Sharpe ratio is Sharpe ratios looking at risk within the portfolio. And just to remind everyone on last week, we talked about standard deviation, right standard deviation is the risk that’s used in the Sharpe ratio. I mean, our standard deviation, it increases even if you perform on the upside. So for example, if you’re a mean return is 10%. And you do 20%, right that you killed it that year, but your Sharpe ratio is going to go up commensurate for that, the way that the Sharpe ratio or excuse me, your standard deviation is going to go up. The way that the Sharpe ratio is calculated is it actually will penalize you for some of that additional up capture because you deviated from your mean, may want I wanted to point that out, because in a moment, I’m asking about another ratio that actually fixes that problem, and one that I actually really like to use because it doesn’t have that upside bias penalty that the Sharpe ratio might have. But before we

9:49
get into scrolling down, jump into it that and I mean, I think that you did a better job of explaining Sharpton than I did. Why don’t you go ahead and jump into it and i’ll i’ll take two fun ones that afterwards. make my life easier.

Jeremy Witbeck:
All right, that’s a that’s a deal. So on the on the ratio front, then since the Sharpe ratio penalizes you for additional upside capture the sortino ratio is the one that I actually think is far preferable and a much better indicator of financial successes within a portfolio. I think the reason why the Sharpe ratio is still utilized as heavily as it is, is it’s one of the first ratios that we learn about in MBA school. I mean, it does have its application. But the sortino ratio actually says no, I don’t care about upside up capture that deviates from the mean, in fact, I want to reward you for that, all that I care about is downside or underperforming the mean. And so sortino ratio is taking half of the standard deviation, which is the bottom half for the underperforming half, that’s Aaron deviation, and then looks at how many units of return you got. And so that’s actually a much better measurement of risk, and one that can really help you see how many units of return you’re getting per unit of downside risk within a portfolio. So to an excellent ratio, but unfortunately, one that’s not nearly as widely used, because, quite frankly, it’s not really taught, at least when I was in grad school, maybe it’s changed then that’s not taught in MBA school. One that, that I think that is not necessarily as well understood, but you get thrown around from time to time job is buy on rumor and sell on news, what is that?

Jeff Powell:
Well, again, one of the things that ends up happening, and it’s not a it’s not a recommended way of investing, I certainly want to make that one very clear. But oftentimes, what ends up happening within the stock market, is that people will be disappointed by what the news is when it actually comes out. So oftentimes, okay, well, ABC company is going to buy out, you know, XYZ company, and so everybody gets excited, maybe they buy into XYZ, because it’s gonna be bought out. And then the news actually does come out and it is true, ABC is buying XYZ. But then they don’t necessarily like the terms of the purchase or something else of that nature. So oftentimes, the rumor can get a momentum going and faster. And then when the actual reality sets in of what’s going on with that news item than the market or that the stock price of a particular company will oftentimes fall off or drop as a result of the actual news coming out. Now, again, not saying to buy it, certainly, you know, we do not say that, you know, insider trading big No, no, buying simply on rumor you’re gambling. But just realize that that’s what this terminology comes from a saying, hey, you’re buying based upon what’s rumor out on the street, that this may be going on. And then when the news actually comes out, you want to get out from underneath it because there’s a better chance and not that the markets will no go back to the private correct party level in order to make sure all this is going on.

Jeff Powell:
Yeah, and just to go to kind of some of the the analogies that you use, I like to refer to this as the new car effect, right. So when you’re going to purchase a new car, right, the excitement, the anticipation, say you’re buying a convertible, you’re imagining rolling the top down the wind blowing through your hair, how it’s going to be an amazing experience, when you get the car, realize that the top down, it’s really annoying to have your hair blown over, it’s rainy, it’s cold, not anything that you thought it would be. And so the actual purchase of the car, once you have, it tends to not live up to the expectations that you had building into it. And unfortunately, it’s the same thing with announcements with companies where a lot of times the rumor is far more glamorous, and far more exciting than the actual news that comes out. And to your point, it certainly leads to different behaviors in the stock price. One last one to top us off, Jeff, and this is one that I don’t think can be understated. It’s certainly true. It’s it’s talked about a lot because of how true it is. And that is that the markets can remain irrational longer than you can remain solvent. What does that mean?

Jeremy Witbeck:
Yeah, so I mean, I get people that will come to me and ask all the time, you know, how is it that the markets are doing this? I mean, even just think about last year, I mean, 2020, if you looked at the fundamentals of what was going on, or the macroeconomics of what was going on, there’s no way in the world that the market should have gone up as much as they did up over 18% of the Year in 2020. So rather than trying to figure out the why, what this is trying to say is stop guessing at why it’s irrelevant. You know, the markets will be irrational, longer than you can remain solvent. So if you’re betting against a market, that’s really the big thing that it’s talking about, you know, price doesn’t lie. So if something is going up or down, price doesn’t lie, you may think that it’s completely the wrong thing. Markets don’t care if they will separate you from your money for no other reason than just, again, they can be irrational. So this, this is one that I really think is a very important lesson for most individual investors, because the person that thinks that they’re the smartest person in the room is normally the one that gets their money separated from them the fastest, because they rationalize why they’re smarter and why what they’re thinking is correct and why everybody else is wrong. So if you and I sat here, we could spend the entire day rationalizing why the market should be going up or down for that matter. So let’s say that we were saying that it should be going down. Markets are going up, guess what? We are wrong. And so again, this key keeps you in alignment with what’s going on going back to the term being your friend and a few other items out there. We want to make sure that we’re being intelligent about this and that we’re not letting our ego come in the way of our investment decisions.

Jeremy Witbeck:
Yeah, well, Jeff, and I think that’s a great way to leave this because it’s a lesson unfortunately, that sometimes take a lifetime for people to fully understand and appreciate. And I do want to recognize one thing, and over the time that I’ve had the privilege of working with you and of course, many more years to come. That is the one thing that I’ve learned from you, that can’t be understated. And that is you can’t have an ego when it comes to the market because of the irrational nature of how the markets work. As much as we want to tout how efficient and how streamlined things are. The fact is, is that the market does crazy things at times that really no one understands. I know people scramble to put a headline to it and talk about it on all the financial news. But the reality is, we’re trying to figure out after the fact a good explanation of what occurred, but in the moment, we really don’t know because there’s so many different variables. And quite frankly, sometimes irrational behavior rules the day or week or month or year, as was found in 2020. So that’s certainly one of those things that I’ve watched you, over time just really embraced. That’s a that’s one of the reasons why Polaris has been so successful. Why our strategies do as well as they are is because we are realistic about the fact that you can only know so much. And there’s always going to be things that you don’t know and pretending that you’re the smartest person in the room to your point just means that you’re going to be the first one that looks like a fool. So Jeff, thank you so much for for going through these. Hopefully the audience had as much fun going through them as I did any guess last pieces of advice as we wrap up for today? No, I

Jeff Powell:
mean, we’ve had a I think a good two part series here kind of going through this one of the things that I guess I would really encourage you to think about what this is try to carry this conversation and with your financial advisor, your wealth advisor, a pluralist, the more that you use a language, the more that it sticks, and listening to this and then not applying it into your daily life means that it won’t stick around for very long. So either come back and revisit this and listen to this more than once or start using the terminology so that, again, it sticks in your memory and sticks into your your knowledge base to be able to communicate with your wealth advisory or financial consultant in a way that maybe your comments surprised and that that, you know more than what they thought that you did.

Jeremy Witbeck:
Yeah, and that’s, that’s great advice, Jeff. And the only other thing I’d add to that too, is that if we do ever use a term that not familiar with, please pause us and have us explain it because we forget sometimes that finance really does have a language in and of itself. And most people don’t use that language every day. And so with that, thank you so much for your time, Jeff. always appreciate your your explanations and also the analogies that you bring to the conversation and to audiences always be happy, be safe and be healthy.

Jeff Powell:
bye Jeremy.

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