A Dash of Insight

Intermediate Outlook Moves to Neutral

The intermediate market outlook from "A Dash" is reported weekly on the TickerSense Blogger Sentiment Poll.  Ticker Sense reports the aggregate vote of participating bloggers, and the individual votes on a voluntary basis.  Here is the history from the site.

We have been reporting our changes in market outlook, although this policy might change at some point.  Many bloggers keep their positions secret.

Our vote this week moves to neutral, from the bullish call we initiated on April 9th.  Since the opening on that date DIA has gained 6.7%, SPY 4.1%, and QQQQ 5.1%.

Basis for Intermediate Forecasts

Our intermediate forecast is based upon work by our chief modeler, Vince Castelli.  One of his models generates signals on individual stocks as well as ETF's and market indices.  The (over-simplified) description of the model is that it captures both trend-following and cyclical characteristics using his proprietary technical criteria.

How We Use This

The intermediate signal influences the overall asset allocation of our managed funds, including the capacity for significant hedging and short positions.

For long-term investors, we make marginal position adjustments with the intermediate outlook in mind.

It does not change our fundamental analysis, including our expectation for a strong second half in 2007.

Not a Recommendation

Readers should note the disclaimer on our site.  We do not make specific stock or market timing recommendations to those who are not clients.  Each person's situation is a little different.  Signals like our intermediate call are often "choppy."  It is not unusual to see the signal make weekly changes at key points.  Many individual investors make mistakes by trying to time the market.

While market timing can be profitable it requires a good method and constant attention.

Whatever one's approach, it pays to be flexible and respond to new information in an objective way.

Musings 6/27/07

Our thoughts on interesting observations, where we cannot do a full analysis.

Great call by Scott Rothbort.  His volatility spike observation last night gave his readers a good entry point for the market.  If you do not have his blog on your RSS reader (as we do) it is time to add it.

Roger Nussbaum highlights a new CBOE  benchmark, probably leading to a tradable index.  Selling naked puts was a factor in the 1987 crash, as I wrote on RealMoney (subscription required and worth it for active traders) today.  There is a good return if the trade is done in appropriate size, but those doing the trade--institutions, market makers, and even individual investors-- got very overconfident in 1987.  Non-professionals should be very careful in determining appropriate size on this one.  More on this topic at CXO Advisory.

Muckdog captures the Fed preview in his typical fashion.  Since he objects to "level headed" we shall just say it always seems to reflect what an intelligent observer might parse from a lot of information.  His presentation is stylishly superior to ours (sometimes criticized as pedantic) and includes useful search optimization terms that we lack.  Check out his post to verify his superior presentation.

Dr. Brett looks at the problem of "chasing" stocks that you like, where you missed the entry.  We suspect that many face this problem right now, and he provides some useful guidelines.  We have discussed this in the past with some stocks that make gap moves after decline, especially Apple Computer, Inc. (AAPL).

Meanwhile, we all await what the Fed says about inflation and the economy.

More on the List of Market Worries

There is an important observation from a great source, Daily Speculations by Victor Niederhoffer, Laurel Kenner, and their team.  This is on our list of regular reads, with a bombardment of stimulating ideas, but thanks to Charles Kirk for highlighting a very interesting post we had not yet seen (as he does so often).

Review of Ken Fisher's Book.

Victor has a number of criticisms of the much-publicized Fisher book,  The Only Three Questions that Count.  Readers should check out his review.  This is on our (growing) list of books to review, so we have no comment at this point, beyond our general respect for Fisher's results.

Here is Victor's nomination for the single best point in the book:

As a final positive note, one thing that Ken Fisher claims in his book that sounds true to me, is that any fear that is widely broadcasted in advance will have no impact on the market. Or perhaps in more predictive terms, to the extent it's influencing the market, it creates a bullish situation because it's already encapped by the price, then price will increase when the fear subsides. Fisher gives many examples to carry his point, and if it weren't so hard to quantify this, and there weren't so many highways and byways to tie down, this would be a very good thing to study.

I feel that this point is highly relevant to sub-prime, and also to the asset seizure on the brokerage house that is famous for seizing the assets of its own customers, (how ironic).

How Timely

This observation is extremely timely.  In a few words, Victor made the point we were reaching for yesterday.  It is difficult to quantify what worries are already reflected in the market.  A good starting point is for investors to ask, when reading the umpteenth article on sub-prime lending or hedge fund problems or spent-up consumers, or housing market problems, whether this seems like new information.

Here is a clue:  If the writer calls it "sub-slime"  or a "meltdown" or 'parabolic" one must evaluate the rhetorical flourish.  Those invoking symbolism instead of writing objectively frequently have an agenda that the reader should understand.

The Fed Model and the Wall of Worry

There are two interesting themes in current market commentary.  There is a connection that is not recognized by either group.  Let us introduce the writers to each other.

Critics of the Fed Model - the First Group

At "A Dash" we have discussed criticisms of the Fed Model, a simple tool that can give the individual investor a feel for the important asset allocation decision.

Many critics test the Fed Model for market timing.  Here is one recent example.  The CXO Advisory blog also has a good summary of research taking this approach.

We believe that this is the wrong way to use the model.  It is better viewed as a gauge of long-term sentiment.  In the bubble era, the model correctly signaled that stocks were overvalued.  When interest rates hit bottom, the  model showed stocks to be vastly undervalued.

The market did not agree  because there was a palpable fear of global deflation.  To take the argument to an extreme, would one pay a 50 P/E multiple for the S&P 500 if interest rates were 2%?  The fear of a recession undermined expectations about forward earnings.  Those fears proved to be unfounded, but the concern was a real one.  The Fed Model showed the sentiment of the time.

Bearish Market Pundits -- the Second Group

There is widespread coverage of various threats to stock prices from the usual suspects, frequently cited on "A Dash".  The issues involved  include topics like the following:

• Housing price declines and an inventory of homes for sale
• Continuing predictions of "mean reversion" in corporate profits
• The collapse of consumer spending
• High energy prices
• A "boxed-in" Fed raising interest rates
• Terrorist threats
• Middle East geopolitical concerns
• Democrats winning the 2008 elections
• And now -- hedge fund blowups like the Bear Stearns case

We may have missed a few, but the idea is clear.  To those writing on these topics, the market has rallied to new highs in the face of these important fundamental factors.  The pundit conclusion is that everyone buying stocks has foolishly ignored the signs that only they can see.

Bringing the Groups Together

An experienced market observer might wonder how so many could have missed the list of concerns.  All of the items on the list get frequent attention in the press, on TV, and in many blogs.  This is not fresh information.

A more plausible explanation is that the market trades at a significant discount to the normal "fair value" for the very reason that investors are very worried about the list of worries.  The Fed Model, currently showing a discount of about 25% on the S&P 500, is a good reflection of the market sentiment.

The bearish pundits focus on worries rather than quantification.  In fact, US stocks have never caught up to the multi-year, double-digit expansion in profits.

Private Equity

Private equity funds have actively exploited the loose arbitrage between low interest rates and high forward earnings expectations from stocks.  The resources for these funds are growing as many institutions seek alternative investments.

We will write more on this topic, describing our conclusion that private equity actions are based upon fundamental valuation rather than a "bubble" phenomenon.  We can only do so much in each post.

There may also be a quiet period in this activity as participants all go on vacation in August.  Some will, no doubt, seize upon this as proof of a "bubble."

Conclusion

US stocks currently trade at a significant discount because of the long list of worries.  These concerns do not represent fresh information.  Most of the arguments raised have been out there for years.  Here is the real contrarian position:

• The Fed continues to steer a wise course toward modest growth and low inflation expectations.  No one seems to believe this, even though predictions of failure by the Fed were the most costly investment research  of 2006 for those who believed it.
• Corporate profits continue to grow.  Many are skeptical about this also.
• The consumer, supported by strong employment, continues to buy.   Many are buying the "spent up consumer" hypothesis.
• Corporations increase investment.  Another surprise.

It is a classic case of scaling a wall of worry, the classic pattern for market strength.  We will see the top in the market when there is massive short-covering, piling in by individual investors, and finally, investment in US equities by foreigners.  We are not even close to these signals.  For the best discussion of these issues, by someone who has been absolutely right for several years, check out the commentary at Between the Hedges.  Take some time to look back at the archives to appreciate the accuracy of the forecasts.

That is why we expect stocks to move much higher this year.

Doug Kass, the Consumer, and my investor, Mark

At "A Dash" we have occasionally written about the work of Doug Kass, who writes the perceptive and helpful trading diary "The Edge" on TheStreet.com's site for active investors.  Doug also is  frequently quoted in Barron's and other publications, and is a regular guest on CNBC.  He is one of the most powerful advocates of the bearish viewpoint.  We have taken issue with some of his methods and argued that his conclusions on some topics, like housing, were directionally correct but overstated in magnitude.

We also again note that we find Doug's work extremely valuable, by itself worth the subscription to RealMoney Silver.  We have profited from many of his ideas, particularly some specific trading calls.

A Communication from Doug

Recently we have had some email communications from Doug.  While not divulging any private email, the gist is that our analysis has been incorrect.  He believes that individual investors like my client, Mark, can read everything and make up their own minds.  Fair enough.

We have invited Doug to reply directly in a comment at "A Dash" citing anything he thinks is incorrect.  Our readers would be further educated by his response, and we would be honored by a visit.

Meanwhile, he might consider allowing comments on his own blog, so that he might enjoy the same reader feedback common in the blogosphere and that we encourage at "A Dash."

Some Help for Mark

Since Doug wants Mark to make up his own mind, it is important for him to have the facts.  Doug is famous for suggesting that the consumer is "spent up, not pent  up."  The following are some relevant quotes from Doug's column.

"If interest rates move higher, refinancings would slow down. At worst, disintermediation would occur and refinancings and cash-outs would plummet.

In summary, the consumer holds the key to the economy and to the stock market. "

"And with the continued delays in the recovery of business fixed investment, general economic expectations and forecasts of corporate profit growth appear too optimistic.

Stated simply, the consumer is spent up, not pent up!

Consequently, I would expect overall consumer spending to grow at an annual rate of less than 1%...."

"...consumers have added to their debt levels -- as measured by borrowings as a percentage of disposable income."

These are all very strong statements and specific predictions, the sort that grab the attention of an individual investor like Mark.

In analyzing the evidence Mark should know that all of the quotations are from Doug's column of November 19, 2002.  The S&P 500 closed at 896.74 that day.

Investment Conclusion

Trying to call a top in investment, consumer spending, and the market is a difficult task.  This is the reason that we look to overall valuation models emphasizing future earnings and interest rates.  These two ingredients drive asset allocation and, most recently, private equity investment.

We do not believe that we are smarter or know more than the experts.  Instead, we try to find the best experts on each subject and make use of their insight.

If interest rates moved a lot higher or earnings forecasts moved a lot lower, our investment perspective would change, as it did in 2000.  We would be very interested in a column by Doug explaining what would change his perspective.  A decline in housing inventory?  An increase in GDP?  Continued strength in corporate profits?  Anything?

Market Outlook

Our market outlook, as reported in the TickerSense Blogger Sentiment Poll, continues to be bullish.  Regular readers of "A Dash" know that we have been bullish on the fundamentals for a long time.  Our vote in the sentiment poll is based upon Vince's technical models, which we use for short-term trading.  That position has ranged, including  neutral or bearish readings in the past, but it has been correctly bullish for much of the run.  We have been on record with a correct contrarian call.

Bloggers Turn Bullish?

The blogger poll has been bearish since its inception, so it has been something of a contrarian indicator.  This week it had a major bullish spike.  Should we be worried?  Stockbee, one of  our daily reads, highlights the issue.  The level-headed Muckdog, whom we view as a helpful voice of reason, makes similar observations.

While we always prefer to be on the contrarian side, we just go with our models for short-term trading.

Inflation?

Another wise voice of reason is Dick Green, the President of Briefing.com.  He has had an excellent record in his overall market perspective for several years.  While we subscribe to the "Platinum" service, well worth it for serious investors, there is plenty of content available for free.

Dick's comments on inflation are worth noting:

The trends are very favorable.  In fact, apart from some pressures in January and February, when inflation rates tend to pick up a bit, there is little sign of inflationary pressures.

The annual rate of increase in the core CPI over the seven months is about 1.9%.  The annual rate of increase in the core PCE over the six months (May data will be out on June 29) is just 1.4%.

He also writes that energy does not change the picture:

The year-over-year increase in total CPI stands at 2.7% compared to the 2.2% increase in the core rate.  The year-over-year increase for the total PCE deflator is only 2.2% compared to the 2.0% core increase. 

A spike in energy prices the past three months has pushed the total indices higher than the core rates, but the impact has not been huge from a broader perspective.

The entire article is worth reading carefully.

The implications of the inflation trend were noted on the Wall Street Journals Economics Blog.  Greg Ip writes that the numbers are so good that the Fed may have to change the language of their statement.

Bonus Idea

Those focused on the headline CPI instead of the core rate have emphasized the trends in food and energy.  We have written about this divergence in an article aimed at the individual investor and a follow-up.

Now let us look ahead.  The energy futures market sees current prices as the new norm.  The forward curve shows a pretty flat picture, indicating that the big-money traders at the NYMEX see modest increases in prices for years ahead.  If they are correct, the headline inflation numbers will stabilize.

For energy to be a continuing source of inflation, oil prices must move higher.  Those who are highlighting this concern can make their bets by going long oil futures.  This is a more direct way to profit than trying to predict an economic collapse and going short on equities.

Full disclosure:  We continue to believe that "upstream" energy companies are dramatically undervalued, so we hold Transocean, Inc. (RIG) and Global SantaFe (GSF).

Musings 6-18-07

Some thoughts that may never become a full post.  Nonetheless, they are all worth reader consideration.

Thinking about risk.  VIX and more gives us a list of great books focused on risk.  This is an important starting point for any investor.  The list includes several that we have studied, some on the shelf but not yet read, and some new ideas for our wish list.

Barry Ritholtz hits the main elements of cognitive bias. This is another theme that any investor must understand.  It's so, so difficult to apply in practice.

David Merkel has a great piece on private equity.  (Any serious investor should take a couple of weekend hours to explore his stock ideas.  He has built a content-rich website in record time.)  Our own piece on private equity has been much delayed, and he hits some of our themes.

The Fly on the Wall sees something coming from Vista and makes some stock picks.  (Full disclosure:  we own MSFT, INTC, and some others in the space.)

David Merkel (again) on how mortgage funds need to adjust.  You have to understand this to interpret moves in the ten-year note, a key market factor.

No correlation between the market and approval ratings, according to Mark Hulbert.  This is going to need some further study.

Journalists are a contrarian indicator on stocks. (Thanks to Paul Kedrosky for citing).  Readers should also check out the long-term record of Ken Fisher at CXO Advisory.

Dr. Brett Steenbarger helps traders and investors alike in the "Trade Like a Scientist Series."  We are citing the final segment, but follow the links to read the first.  Everyone should understand these principles.

Bill Rempel has random disbelief!  This is a story we wish we had written -- just the right touch of humor and insight.  Here's one to add.  Today we read a pundit predicting a recession in 2008-09 based upon housing decline.  Let's stretch out that time frame......

It is often useful to see how the US is perceived across the pond.  Citywire takes a look at actual US economic strength versus data, and provides a perspective on revisions.

To Profess or to Manage: That is the question

The weekend question from my investor, Mark, was certainly on target.  We used the occasion to describe our advice to Mark in the hope that other individual investors would benefit.  We had several interesting comments from our most astute readers, and also a new batch of web postings to worry Mark.

Perhaps we need to do more.

The Crux of the Issue

This is all about whether one wishes to be a professor or a fund manager.  Professors teach classes, do research, and attend conferences where there is often a lot of effort spent in the advocacy of small changes.  Investment managers figure out what works, often by spotting something unseen by others, and generate an investment edge for their clients.  Regular readers of "A Dash" know that I am a hands-on sort of guy who made a career change from professor, to investment researcher, to investment manager.

As a result of this career path, the perspective we take at "A Dash" is quite clear:  We show investors what is working.  We show how to navigate a path strewn with good-sounding debating points which have no predictive value.

That was the point of the conversation with Mark -- to show how we advise investors.

"Core" CPI versus the Headline

The criticisms of "core CPI" rained down upon us over the last few days.  Barry Ritholtz, an early critic of core CPI, further elaborated his viewpoint.   He cited quotations from Bill King, identified as another long-time critic of various inflation measures.  The very influential blog from David Gaffen at the WSJ online, cites several other critics of core inflation.  Doug Kass, who also writes a carefully reasoned and powerful column for theStreet.com, also reviews his long-standing objections to inflation measurement and cites (subscription required, but it might get to the free site soon) a variety of sources who agree with him.  They have also had this viewpoint for years.

We apologize for leaving anyone out, but at "A Dash" we focus on the strongest and most influential exponents for any position.

Why this dog does not hunt...

There is a process for influencing public policy formation.  Academics play an important role, discovering problems and suggesting solutions.  The measurement of inflation is no exception.  The issues were well understood thirty years ago, and the academic literature is active.

There are various problems with the criticisms advanced by bloggers and pundits:

• Their arguments are polemics, not scientific studies.  They play to the lowest common denominator of public understanding, since anyone can see that certain prices are rising.  The arguments ignore all of the difficult measurement questions -- substitution, quality improvements, falling prices in some categories, and how to separate living costs from investment and tax advantage in home ownership.
• Those advancing these arguments lack any economic credentials and often take pride in that fact.  If they really wanted to have an impact, they could write  papers, submit them for a journal or a conference, and participate in the debate.  Peer review settles many disagreements.
• Those criticizing the Fed's use of core inflation measures often seem to have a conflicted agenda.  They are either dedicated short-sellers or have a readership based upon that viewpoint.

The critics could have chosen to attend a conference like the one described here, by a real expert on the topic.  We know that readers will not actually follow the links and read the papers, but scroll down to the final conclusions.

None of the core measures worked that well.  Some picked up turning points better than others in low-inflation periods.  It is an ongoing debate.

Briefly put, the pundits and bloggers are acting like professors, but without doing the work to earn the right credentials, presenting their analysis for peer review, and influencing others who really understand the issues.  They instead are trying to influence people like my investor, Mark, who is just trying to get a good return for his retirement.

Our Perspective

The approach at "A Dash" is influenced by behaviorism in studying political institutions (with an additional strong component of positive political theory).  We try to understand why important decision makers act as they do.  When we write about their reasons, it does not mean that we necessarily agree with them.  It means that we understand their position.  We are trying to help the hard-working, intelligent investor to realize that government decisions are not some conspiracy.  The conclusion reached by the Fed is based upon the strongly held norms of the body, reflected in certain reasoning processes and conclusions.

Readers should also note that we have not done independent research on any inflation measures, so we have no opinion on which is best.  Our role is explaining why important decision makers act as they do.

This is a valuable perspective, unique for our readers.

How to Invest

The critical pundits seem to think that their observations on this topic will cause an epiphany at the Fed Open Market Committee.  There will be a sudden realization that inflation is out of control, and rates will be hiked, causing a recession.

This is not going to happen.

We would not be surprised to see further rate hikes, but it will be a result of continuing strong economic growth.

Please note the following:

• The Fed members and economists know everything that is written by the bloggers and pundits.  They knew it before the bloggers wrote it.  They have chosen inflation measurement methods for a reason.
• The Fed actually believes that CPI overstates inflation.  We know that seems incredible to those who read the barrage of commentary, but it is true.
• The Fed prefers the core PCE deflator as the best measure of inflation.
• The Fed believes that their past actions have already been working to bring core inflation into line.
• The Fed realizes that it cannot control energy pricing by raising interest rates.  The only thing they can control is inflation expectations.
• There will be some advance notice and publicity if the Fed viewpoint begins to change.

Finally -- the Sniff Test

At "A Dash" we have correctly had a bullish perspective based upon our free choice of various strong methods and our understanding of political institutions.  We are prepared to change this viewpoint if and when necessary, as we did for our investors in the 2000 era.

We recommend that readers of other sites employ a simple "sniff test."  If the writer objects to something like "owners' equivalent rent" as a measure, look to see whether the analysis is balanced.  This measure was adopted after many years of debate.  There was a reason.  If the writer does not describe that reason, he probably does not understand it, or he has a hidden agenda.

Ask also whether the writer has a clear path for explaining how the analysis of core CPI is going to lead to new public policy.  If that statement is missing, it is time to do your own homework.

Worries about Inflation: A Chat with Mark

Another month of data shows inflation to be contained while many forecasts for economic growth show a brisk rebound.  The stock market made an appropriate response, so a pleasant weekend was in store.

Then the phone rang.  It was Mark, a very intelligent investor who does a lot of reading from many sources.  Mark was worried about  inflation.

The Conversation

Mark:  I just read the real truth about  those inflation numbers.  First the government fooled us by rounding down the increase in the core rate.  What a joke!  The market did not see that, so it rallied.

Jeff:  We have talked about this before. Do you think that because you divided the price index for one month by that of another, you have information that is better than the rest of the market?

M:  I read it on a web site.  More than one, in fact!

J:  And you think that all of the big money traders did not do the calculation for themselves.  Or read the same web sites?

M:  Hmm.  Well maybe they were off in the Hamptons and the "B" team was on duty

J:  Or maybe the collective wisdom of the market was that a 1.5% annualized rate of increase was pretty good -- better than expected?  Maybe it means the Fed is doing something right.

M:  Why do you say that?  Everyone I read tells me how stupid the Fed is.  They created various bubbles and have basically caused the terrible conditions we have now.

J:  Would you be referring to corporate profits -- at a record with great increases?  Or employment?  At record lows?  Remember what I told you about being a contrarian?  It is easy now.  You only need to think that the Fed is doing a reasonable job.  That seems to put you in the minority.

M:  But they do not understand inflation.  They use some silly core rate with a bunch of adjustments.  I know that my costs are increasing much faster.

J:  As we have before, Mark, we come back to measuring the cost of living.  Here is the simple version.  At any given time, the price of some items is going up and the price of others is going down.  Any fair method has to take this into account.  It is also possible to substitute things that get cheaper for things that are more expensive.  Finally, there are a lot of changes in quality.

M:  Yawn.....

J:   I understand.  When I try to write about measuring inflation, absolutely no one agrees with me.  Everyone -- all non-economists who have NEVER had the job of actually trying to do this -- believe that they know best.  They know better than economists who make a career of this.  They know better than Congressional Commissions tasked with finding the best measure.  I understand.  There are some arguments where a writer can appeal to the lowest common denominator and readers will buy it.

But you see -- that is an investment opportunity.  The Fed is not going to change its view about inflation measures because some bloggers and TV pundits do not understand what they are doing.

M:  Barry Ritholtz says that the Fed will lose credibility.

J:  The Fed is not worried about their credibility on inflation measures.  They are worried about their credibility on containing inflation expectations.  That is why we see so many jawboning speeches.

M:  I know that you are wrong, because I am watching the Big Mac Index and the Martini Index.  Food and energy prices are higher, also.  This is real inflation, not the bogus core rate.

J:  Part of the reason that food is higher is that our energy policy has driven up corn prices.  I wrote about this months ago.  But here is a good test for you.  We can make a little bet.

M:  OK, Jeff, you know I am always up for that.

J:  Here is the bet.  There are certain websites that always find the worst in the data for any week.  This week the core rate was low and the energy prices were high.  There will be a time when the core rates will be high, but the monthly change will be lower.  I will bet you that the websites you are citing will not point that out for you.  Our customary stakes.

M:  We need to agree on the sites.

J:  Of course.

Here is a bonus --

Let us assume for a minute that energy prices were rising, basically because of OPEC control.  What would be an appropriate policy response?

Those writing at various perma-bear websites seem to think that the Fed should hike interest rates.  These guys need to review their Econ notes.  Tightening rates to kill demand is not a good weapon against cartel pricing.

While the Fed does not discuss it much, the members of the Open Market Committee and their 350+ economists are smarter and more knowledgeable than the bloggers.  While they want to control inflation expectations, they are not going to crush the economy in a pointless move against energy prices.

The next time someone wants to give you a lesson about "core inflation" you should think  about that concept.

Misusing the Most Powerful Computer - Part 2

Those who do not understand research  methods have been empowered to make mistakes.  Computers permit backtesting and curve-fitting.  The system developer who takes ALL of the past data develops a perfect model -- perfect for "post-diction."

Background

Using data to develop predictive models is much more challenging.  The process involves -- minimally -- holding out-of-sample data for testing.  Better yet is extensive testing on different stocks and time periods.  Anyone who does the systematic  development of models understands this or quickly fails as a trader.

Misuse of the Most Powerful Computer

The most powerful computer is the human mind.  It can be easily abused.  The mistaken process is a simple one.

Start with the conclusion one seeks.  Then find the pattern.

A few months ago we described how many pundits were using this method by finding charts.  If one starts with the conclusion, it is easy to find charts that support it.

An objective, scientific approach would be to find all chart patterns describing a particular "setup" and then look at what happens.  The best analysts do this.  One often finds that there are not enough cases for reliable inference.

Making Comparisons with Words

We now see many analysts who use words to accomplish the same objective as the chart abusers.  Pundits see the current market as similar to that of 1929, or 1937, or 1974, or 1987, or 2000.  The debate rages among bearish pundits about which disaster scenario is most comparable to the current market.

Here is a useful "sniff test."  Remember back to your college days when you had an essay question that asked you to "compare and contrast."  If the writer makes no effort to do both sides of the analysis, just move on.  That writer is not making a serious effort  to analyze.

The Case of 1987

Helene Meisler, an excellent technical analyst who writes for RealMoney (paid site at the.street.com and worth it for serious investors) was asked to put up a chart comparing 1987 to the current market.  She did so.   The chart  did indeed show a pattern similar to the current market, but her conclusion was that it is not really a similar case.  She cited a number of technical factors.

The Real Story

I posted a comment on RealMoney that provided the "contrast".  This is pretty easy to do in any of the proposed comparisons, but an analyst with an agenda will not provide this for the reader.  Here is the contrasting 1987 analysis, as I wrote it:

Meanwhile, I am also getting questions about the 1987 comparison. It has been written about enough to worry some of my clients. I see (at least) four important differences:

1) Any valuation method that uses both earnings and interest rates shows stocks very overvalued in 1987 and very undervalued now.

2) Individual investors were "all in" on mutual funds and then they headed for the exits all weekend before the Monday crash. The process of handling redemptions was clumsy. The individual investor of today does not have the same equity exposure.

3) The system of 'portfolio insurance' gave institutions an unfounded sense of complacency. Managers believed that they could sell futures contracts to hedge positions after a big decline started, so they were also "all-in." This is akin to buying insurance after your house is on fire. The post-crash discussions (and there are many fine ones) all emphasize this dependence on prospective selling of futures. There were also no circuit breakers. Today's managers have learned this lesson, and put premiums are low.

4) The complacency was so great that individual investors regularly sold naked puts as a means of generating monthly income. You can see the ads for such "systems" in the issue of Barron's that came out the day of the crash. Aggressive put-selling, especially by naive investors, is a good measure of complacency, and something you do not see now.

Conclusion

This is not 1987, but it is easy to be misled by facile comparisons and charts.  If the writer does not seem to be providing a balanced analysis,  just say "no" and move on.