O'Shaughnessy on Investor Psychology, Bond Market Trouble, and Why Value Wins

In a wide-ranging interview with Barry Ritholtz on Bloomberg View, quantitative investing guru James O’Shaughnessy recently talked about why human beings are such inferior prognosticators compared to computer models, what that means for investors, why stocks may well be safer than bonds over the long run, and why holding period duration is so critical.

O’Shaughnessy talks about how buying overpriced stocks leads to horrible long term returns, but how many people are drawn to such stocks because they have exciting stories behind them. He also discusses the importance of examining long periods that cover many market cycles when assessing what works on Wall Street.

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O’Shaughnessy also talked about how he got involved in quantitative investing, and why he thinks it is such a worthwhile approach. He discusses temperament, noting that quantitative strategies have a built-in error rate, meaning you need to be comfortable with the fact that you won’t be right on every pick.

As for the current market, one area in which O’Shaughnessy sees value: international dividend stocks. One area he sees a lot of reason for concern: the bond market. O’Shaughnessy says that the falling rate environment of the past 30 years is an aberration, not the norm. Even “simple, judicious” increases in rates — which are likely given the current situation in the US — would very negatively impact the bond market, he says. While many see bonds as a safer asset class than stocks, O’Shaughnessy says that when you look at longer holding periods, it’s stocks — not bonds — that are the safer pick.

O’Shaughnessy also talks about the importance of holding periods. He says that if your time horizon is less than 5 years, you should not have any money in the stock market. “Over five-year periods, you can be absolutely wiped out,” he says. He cites one study from Fidelity that found clients whose portfolios fared best were those who had actually forgotten that they had an account with the firm, meaning that they had stayed invested over lengthy periods rather than engaging in frequent jumping in and out of the markets.