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Protecting Against Inflation - and Maximizing Yield.

Protecting Against Inflation - and Maximizing Yield

I wish to thank Mr. Robert Puelz (1988) for his numerous complimentary remarks in his review of my book entitled Protecting Against Inflation - and Maximizing Yield. The book was intended to sensitize financial service professionals to the horrors of decreased purchasing power; to provide useful information about insurance product performance; and to provide clear information about Life of Georgia's experience with the Cost of Living policy, in the hope that other insurers will answer the challenge of inflation. I am glad that Puelz found the ideas about future financial products to be thought-provoking. However, there are a number of points which I would like to clarify.

Puelz states: "Although written with an investment fund manager in mind, this book can just as easily be understood by a novice." The book was, in fact, written for "investment fund managers, but who are not professional managers themselves; persons designing financial services products; owners of some financial services products, who are expected to make their own investment decisions in spite of lack of professional expertise in the field (this would include owners of universal-variable plans and numerous other products); and life insurance agents and financial services professionals who find themselves in the position of discussing investment strategy questions with clients. Investment results have become too important to leave solely to the fund managers.

I take exception to Puelz's remark: "In some ways the credibility of the book is tainted by the inclusion of the chapter on investment strategy." That chapter reaches the optimistic conclusion that investment performance can overcome inflation. This is a fundamental point, making the various financial services products viable. Because of this fundamental point, and because this is a book about inflation, it was necessary to explore how investment performance, which might overcome inflation, could best be achieved. The chapter on investments certainly did need to be included.

Mr. Puelz discusses the Theory of the Economics Series, which is at the core of my investment strategy. I will summarize the strategy as follows: - The business cycle can be broken down into four periods - one optimistic, one pessimistic, and two changing. Investment yields and other economic results vary remarkably from one period to another; this is especially true relative to three principle forms of investments: three month bills, long term bonds, and common stocks. To achieve the most satisfactory protection against inflation, this variation must be understood and used. Various trading strategies are considered; the one recommended in the book is the Prudent Mixture Strategy. Any trading strategy depends on determination of economic period. The book suggests the theory of underlying mood as one means of determining economic period; this is a controversial suggestion which might just turn out to be correct.

Puelz apparently has difficulties with the efficiency implications of the theory. The "Efficient-Market Hypothesis" is often described and research by financial writers, but not all agreed with it. Farrell (1983), for example, after a thorough discussion of the hypothesis, states: "There is opportunity for managers to develop superior insights with the potential for above-average performance." I myself disagree with the efficient market hypothesis because of long observation of the fact that fund managers, when faced with the same set of circumstances, do not al take the same course of action; their courses of action can differ very widely.

Puelz also has difficulties with the underlying mood theory. He states: "no doubt psychiatrists knowledgeable in projectionism would have certain arguments against the accuracy of a single investor's measurement of the state of social psychology." The underlying mood theory was developed in consultation with a distinguished professor who is an authority on psychiatric phenomena, and who believes very strongly in the theory. I can say also that economic period need not be determined by a single individual; it can be determined by consensus judgment of experts in various applicable fields. Puelz also states: "Reasonable people must ask why this theory would fare better than another theory", but does not mention any such other theory for determining economic period. (Waiting until the economic statistics have appeared is probably too late!) I believe there is a dearth of good theories for this purpose. I would be very happy to see such theories developed and used. As I stated in the book: "Any effort to determine economic period is worthwhile because the best investment strategies differ so remarkably from one period to the next."

It is my hope that the book will stimulate new thought on an important subject: protection against inflation. Puelz's review is a fine contribution along these lines.


[1.] Puelz, Robert, 1988, Review of Protecting Against Inflation - and

Maximizing Yield, The Journal of Risk and Insurance, 55: 773-74. [2.] Farrell, James L., 1983, Guide to Portfolio Management (New York:

McGraw-Hill) 21-23.

Protecting Against Inflation - and

Maximizing Yield, by John M Bragg:

Reviewer's Reply

The chief disagreement between Mr. Bragg and me concerns our divergent attitudes about the efficacy of efficient markets theory, and whether or not the costs of an active investment philosophy are more than compensated by the uncertain benefit of abnormal returns. For example, Bragg's "Theory of the Economic Series" is dependent on the notion that social psychological moods can be determined, and that a resolute state of social psychology is associated with an optimal portfolio mix which enables investors to maximize yield. My contention with Bragg is not in the accurate gauging of the state of social psychology. In fact, assume that the psychological mood of society can be ascertained. Then the semi-strong version of efficient markets theory would argue that if one investor, or a set of investment experts can sense a mood, and the costs of "sensing" are low, then other competitive investors must be able to sense a mood as well; therefore, abnormal returns would be non-existent.(1)

Certainly the debate between Bragg and me is not new. Since the work on models of equilibrium in capital markets began (Sharpe, 1964; Lintner, 1965; Mossin, 1966), there has been much discussion between advocates of the traditional approach to investment analysis and efficient market theorists. Academic researchers have shown that anomalies such as the small firm effect (Banz, 1981) and the "January" effect (Keim, 1983) exist, and that markets may not be perfectly efficient. The unresolved question directly related to Bragg's thesis is whether the costs of his active investment strategy are more or less than the benefits of returns in excess of the return on a well-diversified market portfolio; a return that may be obtained with inconsequential transaction costs. If the answer to this question is that the Theory of Economic Series produces superior returns, then one must ask why Bragg would ever let such valuable, proprietary information into the public forum? The very action of making such information more readily available implies that investors, faced with the choice between engaging the Theory of Economic Series and purchasing a stake in an index mutual fund, ought to choose the latter to maximize yield.

(1) For a test which validates the semi-strong efficiency hypothesis with regard to the information used by security analysts, readers are referred to Davies and Canes (1978).


[1.] Banz, R. W., 1981, The Relationship between Return and Market Value of

Common Stock, Journal of Financial Economics, 9: 3-18. [2.] Davies, Peter L. and Michael Canes, 1978, Stock Prices and the

Publication of Second-Hand Information, Journal of Business, 51: 43-56. [3.] Keim, Donald B., 1983, Size-Related Anomalies and Stock Return

Seasonality: Further Emprical Evidence, Journal of Financial Economics,

12: 13-32. [4.] Lintner, John, 1965, Security Prices, Risk, and Maximal Gains from

Diversification, Journal of Finance, 22: 587-615. [5.] _______, 1965, The Valuation of Risk Assets and the Selection of Risky

Investments in Stock Portfolios and Capital Budgets, Review of

Economics and Statistics, 47: 13-37. [6.] Mossin, Jan, 1966, Equilibrium in a Capital Asset Market, Econometrica,

34: 768-83. [7.] Sharpe, William F., 1964, Capital Asset Prices: A Theory of Market

Equilibrium Under Conditions of Risk, Journal of Finance, 21: 425-42.
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Title Annotation:comment on a book review and authors reply
Author:Bragg, John M.; Puelz, Robert
Publication:Journal of Risk and Insurance
Date:Mar 1, 1990
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