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« The Sector Update -- Current Recommendations | Main | Choosing what to read? »

September 16, 2007


Mike C

I think the previous commenter hit the nail on the head (regarding time frame).

The extremely important question which I think ultimately is unanswerable is what time frame is relevant? Especially if the past 10 years have been radically different then the 30, 50, 80 years that preceded it (in terms of how stocks are valued). Do you base your forward-looking decisions on models that worked over the previous 10 years or models that worked over the past 50 years?

I sincerely do not know the answer, but anybody who doesn't realize they are in fact making that choice is potentially taking a risk they are completely ignoring or unaware of. I suspect 10 years from now we will know the answer.

One should certainly pay alot of attention to those who have solid long-term track records. However, I am inherently skeptical of "consensus" positions. Often, the correct and most profitable positions are those that are anti-consensus and contrarian. What was the consensus view in March 2000? What was the consensus view in October 2002? What was the consensus view on gold in 2001? Central banks who presumably would fit the bill of well-credentialed, "experts" in their field were net sellers of gold from 1999-2001.

Very often the consensus is most bullish at the top and most bearish at the bottom.

Interesting that the question was framed with "bearish" blog instead of "bearish/bullish" blog. I would think one could be equally as susceptible to confirmation bias regardless of whether one is a bull or bear. I don't think it would just be bears who are guilty of confirmation bias.


Another explanation could be that over the last 10 years, a certain method or set of indicators shared by the top 10 has performed well (when viewed from today's market level), relative to other possible methods and indicators. This would make those 10 tend to have a consensus going forward as well. However, it would not (necessarily) mean that their approach will work in the next year (or ten).

There are certainly plenty of behaviors that would have worked over the last 10 years that would not have worked in all 10-year periods, even periods overlapping the trailing 10 years.

An interesting test would be: were these same 10 the top performers when viewed from the bottom of the bear market?

I don't know whether the above is the explanation, but I don't see any evidence to rule it out.

So there's something to be said for looking at indicators or methods that have longer track records. Some of those, such as price to normalized earnings ratio, are currently bearish.

Second, it seems critical to ask what time horizon a given pundit is making a claim about. Price to normalized earnings (a proxy for fundamental value) statistically predicts long-term (7-10 year) returns well, but does not predict much about what will happen next month.

So if you are market-timing day-to-day, fundamental value is not helpful. If you are market-timing to try to limit downside risk over a multiyear market cycle, perhaps it is. Approaches based on fundamental value avoided both the tech bubble gains and tech bubble losses. Some people would consider that a positive and others wouldn't.

Finally, "risk-adjusted" has its limits. Usually this means adjusted for volatility. But risk does not have to be reflected in volatility; a classic example is "pennies in front of a steamroller" strategies such as writing out-of-the-money puts. A steadily-rising bull market getting ahead of fundamentals is not so different; on most days it goes up, but it has the potential to take a big dive. If someone is highly downside-risk averse, staying bearish much more often than necessary is not irrational, and it isn't wrong to say that risk is elevated when valuations are elevated.

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