“What Works On Wall Street,” an exclusive interview with best-selling author and financial expert James P. O’Shaughnessy
John Nyaradi: Hi everyone. I’m John Nyaradi,
publisher of Wall Street Sector Selector, the financial media site
specializing in exchange traded funds and global markets. Today, I’m
really pleased to welcome our special guest, James O’Shaughenessy.
James, welcome to Wall Street Sector Selector.
James O’Shaughenessy: Thanks for having me on, John.
John Nyaradi: Thank you. James is chairman and CEO of O’Shaughenessy Asset Management. He has been a portfolio manager and Senior Managing Director at Bear Stearns. He’s the bestselling author of “What Works on Wall Street: What Works on Wall Street, Fourth Edition: The Classic Guide to the Best-Performing Investment Strategies of All Time.”
He’s widely recognized as one of America’s leading financial experts
and he’s known as the pioneer of quantitative equity analysis. Barron’s
has called him a “world beater, a statistical guru, and a legendary
investor.” Kiplinger’s Personal Finance magazine has said, “You ignore
his message at the risk of your own future wealth.”
Today we’re going to talk about James’s new book and his view of the
market. So let’s just start with a big picture of the book, James, “What
Works on Wall Street,” the 4th edition of this book, “The Classic Guide
to the Best-Performing Investment Strategies of All Time.” What’s your goal is here, what do you want people to get out of it?
James O’Shaughenessy: Well, my goal is for the
reader to be able to have access to a long-term study of which factors
and strategies work well in a variety of stock markets.
This version of the book actually has data for some of the factors
going back to 1926 so we actually are able to test some strategies
through the Great Depression. We thought that was pretty important after
2008 turned out to be the second worst year since 1931. But what we
really are trying to do is educate investors as to which strategies
work, why they work, and how the investor can take advantage of them. We
also have chapters on what the roadblocks are for success and
investing, and typically, what we found was that the roadblock tends to
be the investor themselves. When they let emotional decisions get in the
way of good investing, they cost themselves a great deal in terms of
wealth that they could have in the portfolio but don’t because they make
decisions through their emotions rather than through their logic.
We have a new chapter talking about neuro finance, which is
essentially scientists taking super fast pictures of the brain when
people are making decisions, financial decisions under uncertainty. What
we found from that was that it is not the prefrontal cortex which is
firing during those decisions; it’s the emotional centers of the brain.
And if investors can get their mind around that and figure out that
we’re all the same, we all will react emotionally, and if they can
conquer that, that’s one of the key roads to succeeding over the long
John Nyaradi: You’re a market historian and this
book is over 600 pages just packed with data. As retail investors we
hear, “Is this time any different, does history repeat, does it rhyme?”
What’s your view of that?
James O’Shaughenessy: I think that history
definitely rhymes. You have to remember that at the end of the day
people will often say to me, “Well, you know, what use is looking at
data from the 1930s or 1950s; the world is a completely different
My response is always that the one thing that hasn’t changed is that
human beings are the ones who price securities and we have not changed
at all. So, you know, there’s a piece in the book showing the South Sea
Bubble, which was an internet stock of Isaac Newton’s day, and you look
at a graph of it, it goes straight up and straight down. Of course,
Isaac Newton, one of the brightest men of all time lost a fortune and it
caused him to lament that he could measure the motion of heavenly
bodies but not the madness of men. But then right next to it, we have a
graph of the NASDAQ 100 and guess what, they’re identical, they look
exactly the same, and that’s because human beings were pricing those
bubbles. They got inordinately excited about prospects for the
investments. Those prospects didn’t pan out and, of course, they
What we have found is that there are good sound strategies that
individual investors can use that work very well over time. I’ll give
you an example. We have the ability to test investing in companies that
are market-leading companies with sound financials and good economics
that have high dividends. Well that strategy worked very well from the
’20s forward. It’s a fairly easy strategy to follow for the individual investor and it has paid, excuse the pun, wonderful dividends for the last 80 years.
John Nyaradi: You just mentioned that we’ve been
through the second worst period since the 1900s. So should investors
believe in stocks? I mean a lot of people have left the stock market,
what do you think about this?
James O’Shaughenessy: I think absolutely they should
believe in stocks. In the book, we covered the 50 worst ten-year
periods since 1876, and the ten years ending February 2009 were actually
the second worst ten years since 1876. The worst ten-year period was
the one ending in May of 1920 so you had to go back a long way to get
one that was worse. But what was more important to us than the damage
that was done was what happened afterwards. So we looked at one year
after, three years, five years, seven years, and ten years and what we
found was really fascinating and very encouraging for equity investors.
Once you get to the three-year mark, there are no negative numbers, not
one. In any of these 50 worst periods, they are all followed for three,
five, seven, and ten-year periods by excellent equity returns.
If you think about it, that makes a lot of sense. What happens after a
horrible ten-year period? Valuations get compressed, PEs go down, and
dividends go up. So investors find themselves in a position where the
market itself is so much better priced for them to succeed and yet
what’s holding them back is the fear that got generated by having to
live through that rotten ten-year period so it’s a bit of a Catch 22.
But what we’ve found was very encouraging in terms of equities. When you
can look and see no negative numbers in 50 of the worst ten-year
periods, that’s a very positive thing.
John Nyaradi: How about the bond market? People have fled to the bond markets in drove. What do you see there?
James O’Shaughenessy: I think that is classic
investor behavior. What happens is investors run out of markets that
have been disappointing and into the market that’s been doing very well,
and traditionally that’s not a very good way to invest. I mean, think
of the hapless investor who put all their money in tech stocks in the
late ’90s and then that crashed and so they thought, well I’m going to
put in real estate and then that crashed and then they put it in the
The thing about the bond market is it is coming off possibly its best
40-year period in history. What people don’t understand about bonds is
that they can go down very rapidly, much like stocks if interest rates
go the other way. So if we are entering a period where interest rates
are going to go up, that pushes bond prices
down. So I think that investors should be very wary of thinking that
they have great safety in bonds when, in fact, historically, you can see
that there have been 20, 30-year periods where bonds lost money on a
real basis after adjusting for inflation. So I would be very wary of
being in the bond market right now.
Instead, I would suggest that investors who are hungry for yield look
to those high dividend stocks that we discussed a moment ago. Their
balance sheets are in much better shape than the sovereigns are and
we’ve kind of switched places here. You know, you have these
corporations with the cleanest balance sheets that they’ve had in years
and you have sort of government in disarray. I think that’s one of the
things that investors will want to take or keep in mind is that the fact
that bonds really have had, you know, an almost unprecedented rise. You
can’t go below zero in the interest rate market. So when they’re
rushing into the bond market, basically they’re rushing to something
that is at or near the peak of where it’s going to be and they’re
receiving very little compensation in the term of yields. I mean with
the ten-year treasury well under 2% and when you get inflation back into
the mix, that’s not going to be a pretty picture for individual
John Nyaradi: In your book you have a dozen or so
more different kind of strategies that people can use to analyze the
market and then you mentioned that many strategies that people use are
mediocre. Do you have a favorite strategy or a combination of
James O’Shaughenessy: Well, I have two for you. For
conservative investors or people who are in retirement, the idea of
finding market-leading companies with strong financial strength and good
earnings quality that pay high dividends is an excellent strategy and
fairly conservative. On the other end of the spectrum, one of the best
things that we have found is marrying stocks that show great value
characteristics like low PE ratios, low price to sales, etc, and then
buying the stocks from that group that have great price momentum. That
strategy actually proved to be one of the best performing of all the
strategies. But the caveat that we like to issue there is it tends
towards the smaller cap and mid cap space and it can be a lot more
volatile. So it’s definitely a strategy for people who can stick with it
when it’s not working and who have at least a five-year time horizon.
John Nyaradi: We’ve all heard various market clichés and one is the random walk. What’s your view on that? Is it random walk on Wall Street?
James O’Shaughenessy: It is absolutely not a random
walk, it is a purposeful stride. You know in one of the chapters, we
show what market volatility would have to look like if it was a random
walk. What happens in the stock market is human beings price securities.
Sometimes they get it very, very wrong and that’s a huge opportunity
for those of us who have the patience and the diligence to go after
those stocks that are mispriced.
John Nyaradi: This is the fourth edition of your
book. The first one was in 1996 and now you can look back and the
strategies that you outlined in 1996 walking forward in real time have
actually outperformed and had good results. Can you just touch on that
for a moment?
James O’Shaughenessy: One of the first things when
we published the book was people said. “Well, you’re saying how to do
it, it’s not going to work anymore,” and that has been very far from the
truth. One of the things that we always want to underline for investors
is there’s no single strategy that works all of the time. What you’re
trying to find are strategies that work most of the time and work well
and then you’ve got to make the bargain that when they’re not working
well, you’re just going to stick with them. It’s the key of sticking
The S&P 500 beats 70% of professionally managed mutual funds over
any ten-year period and it does so not because it’s a great strategy,
but because it never varies from that underlying strategy. It doesn’t
wake up in the morning and say, “You know what, today I’m going to be a
small cap index or today I’m going to be a bond index.” It just remains
fully invested in those 500 large cap US companies and by doing so it
puts time and history on its side. Time simply because of the
compounding effects of your investment returns and history in that since
the founding in the New York Stock Exchange, returns in the US have been positive 71% of the time.
But the key to it and the reason it beats the majority is because it
doesn’t change. It sticks with it. So the S&P beats because it is a
disciplined approach to investing. If you stick with other strategies in
the same disciplined fashion, you can do considerably better than the
S&P. As a matter of fact, in the book from one of the final
chapters, we list all of these strategies by performance and what we see
is the S&P comes in the bottom third of all the strategies we’ve
tested. It’s beating that majority because it just stays the course.
John Nyaradi: I always like to end these
conversations by asking if there’s anything else you’d like to add?
Maybe one thing that’s maybe really on your mind right now? We’re
talking in December of 2011, is there anything that people should be
watching out for?
James O’Shaughenessy: Well I think we’ll end as we
started. People have to watch out for themselves. Remember the Pogo
cartoon that said, We’ve met the enemy and it’s us?” I think that the
more people understand that it’s not just them who get emotional but
it’s every human being. They’re proving it scientifically now with these
brain scans and if we can understand that we all are going to have
exactly the same reaction and then find a way to overcome that emotion,
we’re going to succeed in investing.
I always say that the four horsemen of the investment apocalypse are
fear, greed, hope, and ignorance and only one, ignorance, is not an
emotion. The other three, fear, greed, and hope have wiped out more
portfolio value than any bear market in history and the more people
understand that, the more they’re able to get their emotions in line and
understand that they’re not any different than anyone else. Everyone’s
reacting the same. But if they can stay the course, they will succeed
John Nyaradi: Folks, we have been talking to James
O’Shaughenessy, chairman and CEO of the O’Shaughenessy Asset Management,
previously managing director at Bear Stearns, bestselling author and
widely recognized financial expert. At more than 600 pages, “What Works on Wall Street, Fourth Edition: The Classic Guide to the Best-Performing Investment Strategies of All Time”
is really like a Master’s Degree in finance or investing. It has
received extremely positive reviews, it’s high on the investing and
financial bestseller lists and all of that is certainly well deserved.
I’d like to add my humble endorsement to say it’s a very serious book for serious investors. Click on this link to learn more about “What
Works on Wall Street: What Works on Wall Street, Fourth Edition: The
Classic Guide to the Best-Performing Investment Strategies of All Time.”
To learn more about James’s work, click here or just follow the link at the end of this interview.
It has been wonderful chatting with you today, James. Thank you very
much and thanks for joining us. I know we’re all looking forward to
talking with you again soon.
James O’Shaughenessy: Thanks, John.
Learn More About James O’Shaughenessy
(recorded interview, edited for clarity and length)
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12-19-2011 12:05 PM