In last Thursday’s Separating Signals from Noise I closed with:
“From Tuesday morning’s featured quote:
“…popular math tools and risk models are incapable of sufficiently preparing investors for large and highly unpredictable deviations from historic patterns—deviations that occur more frequently than most models suggest.”
“What you’re really modeling is human behavior,”
Yes, we can talk price to earnings ratios, market cap to GDP. We can discount cash flows. We can crunch macro data till we’re blue in the face. We can measure volatility in markets back a century and look for patterns that correspond with history’s major market moves. We can measure flows into and out of equities daily, weekly, monthly, yearly. We can read sentiment surveys, measure spreads between those who say their bullish for the next six months and those who say their bearish. We can carefully chart the difference in yields of low quality corporate bonds versus super-safe treasuries. We can track daily volume in equities, compare up volume versus down, we can track the daily gainers versus the losers, up sectors, down sectors. We can track purchasing manager surveys, chart the costs of commodities across the spectrum. We can perform technical analyses on everything we hold in client portfolios, and a myriad of things we don’t… on and on and on…
We can do all of the above (which we do), and so much more (which we do), and when it’s all said and done, we’re simply monitoring human behavior, forming hypotheses, and investing accordingly.
So why all the effort? Don’t I always say that human nature never changes?
Well, sure, based on my studies of human investor nature over literally centuries, I conclude that indeed, folks tend to act in similar ways at the ends, and at the beginnings — and in the middles for that matter — of long market up and down cycles. But, of course, it’s all about the timing, and forever working to separate the signals from the noise (wherein those “deviations” mentioned in the above quote occur).
And, man, my friends, markets are mighty noisy these days!
Stay tuned.. and stay hedged!”
Once again, calling on the timeless wisdom of Alan Watts, I’m reminded that human nature — it’s ultimate repetitiveness — be what it may (i.e., the above notwithstanding), we must nevertheless remain forever humble and open to new discoveries:
“If we are open only to discoveries which will accord with what we know already, we may as well stay shut.”
“It is in vain that we can predict and control the course of events in the future, unless we know how to live in the present.”
“It is in vain that engineers devise faster and easier means of travel if the new sights that we see are merely sorted and understood in terms of old prejudices.”
“Tools such as these, as well as the tools of language and thought, are of real use to men only if they are awake—not lost in the dreamland of past and future…”