“To one who has faith, no explanation is necessary. To one without faith, no explanation is possible.” – Thomas Aquinas

Both the atheist and the faithful have the same fundamental problem: there is no way either can prove their point because it requires knowledge of the future after death. While both can argue that they “know” whether God exists, or does not, neither truly knows. The atheist may point to data point after data point which denies the existence of a Creator, similar to someone who only sees white swans in history with each prior white swan reaffirming that fact, until the magical Black Swan appears. The faithful may or may not have data points to support their faith, but faith does not require proof in the near-term, small sample of life relative to eternity. Belief Is faith in an unseen and unknown future, which is something related to life after death.

With my travels around the country over (at least for this year), I’ve had much on my mind as it relates to this business of investment management. The atheist and the faithful both are making an inherent prediction about the future which no one can prove until the future becomes the present. The same applies to investing. Both the bull and the bear speak confidently about why stocks, bonds, commodities, or currencies will do this thing or that thing based on data points or faith about cause and effect, yet no one despite that confidence truly knows whether they are right or wrong until after the fact. The atheists in markets would have said that buy and hold investing was dead in March 2009, and that the buy and hold model was broken. The faithful would say quite the opposite, despite suffering a severe beating financially in the midst of brutal bear markets and crashes, and likely losing their sanity as colleagues, friends, and enemies scream about how wrong they are as the world falls apart.

There is logic, however, in being faithful, and in believing. In the midst of the market collapse during the post-Lehman free-fall, you needed to believe that things would be okay. If you didn’t, you inherently then believed capitalism was coming to an end, and in turn needed to leave your home, buy guns and butter, and get the hell out of dodge. From a payout perspective, there was logic in having faith that the world would survive and that buy and hold was not broken, but rather broken in the small-sample. Those familiar with Pascal’s Wager recognize probability theory. Assuming that there is indeed infinite gain or loss from believing in God (spending eternity in heaven or hell as defined by your religion), you might as well believe. The downside if there is no God? No heaven, no hell – a definitive end in time.

Why am I bringing this up in this week’s writing? Because in my travels, those whom I have presented to and have watched my full blown presentation on our award winning papers range from the atheist to the faithful when it comes to our research and our approach. In one of the slides showing the beta rotation 2014 Dow Award strategy, I show that 80+% of the time on a rolling three year basis, that approach outperforms the market. That in turn means 20% of the time on a rolling 3 year basis it’s not working…it’s “broken.” I always ask the crowd what each would do if they happened to launch that strategy in the 20% of the time on a rolling 3 year basis it’s not working. Would they stick to it? If they manage money, will their clients let them in a world of instant gratification, myopic thinking, and tremendous noise? Some will shake their heads no. Yet, 80% of the time it’s working. Is that not utterly insane to think that when you’re in the 20% of the time its not “working,” you should abandon it?

Yet, those who think a strategy is working or failing in the small sample are no different than the atheist who cannot prove the future, nor prove whether signals aren’t working because of cycles, or because of something that is forever changed in market dynamics. As managers of an alternative strategy and equity sector one, we choose to have faith because we know the research and know the anomaly which exists we are trying to take advantage of. We know our research, and know that we have factually been living in an outlier period. If you believe the two day rip higher Wednesday and Thursday in stocks is common, that is factually incorrect. Yet, the outlier is what we are judged on, rather than longer term probabilities.

The Fed has said nothing new whatsoever. A strong recovery occurred in junk debt, but that needs to hold for the move to persist. Meanwhile, yield curve flattening dynamics have not changed one bit. Nor has underlying fragility in nearly everything but the S&P 500 (SPX), which everyone now seemingly has faith in after its omnipotence has revealed itself since the March 2009 low. There are no more atheists anymore when it comes to buy and hold investing in large-caps, much like was the case in July 2007. The future, however, does not reward those who have 100% knowledge of what’s to come, but rather the faithful who in the absence of foresight still believe.

The faithful are no longer those that buy stocks which are “hitting new highs” (factually wrong – only an index is hitting new highs, not stocks). The faithful are now those who believe that return cannot be generated without risk. The faithful are those who actually understand that volatility and corrections are predictable as outlined in our award winning papers, and act to manage that risk despite data point after data point which after the fact says to not manage that risk in the small sample. The faithful are those who recognize the fact that the best strategies must by definition have a large number of false positives, because the only way for an anomaly to persist in markets is through disbelief, otherwise it gets arbitraged away.

As we close in on the Holidays, we maintain our faith, believing that stocks are not a guaranteed source of return, and that risk management will matter again which in turn benefits our approach to being aggressively defensive using proven leading indicators of stock market volatility. Indeed those leading indicators appear “broken” to those who fail to understand probabilities and fall prey to small sample bias despite all history that says quite the opposite. That’s okay – it’s not supposed to be easy to have faith.

I have a feeling Pascal was perhaps the best trader of all.