Monday, 6 December 2010

Macro and Markets - the importance of studying the past and making its own judgement.

"Life can only be understood backwards; but it must be lived forwards."
Søren Aabye Kierkegaard (5 May 1813 – 11 November 1855)

When approaching Macro trends as well as markets, it of the utmost importance to study what has happened in the past, in order to move forward and making its own judgement, meaning evaluating the evidence in the making of a decision with great humility.

Reading through some fantastic book: The Intelligent Investor by Benjamin Graham, Contours of the World Economy by Angus Maddison, Fooled by Randomness by Nassim Taleb, I came to a similar conclusion on different levels.
In this era of information overload, it is becoming increasingly difficult to select important information/data from noise.
By moving back and forth and studying the past with the present, it enables oneself to make better assumption of the evolution of a market or a macro situation.

As Mark Twain once said: "History doesn't repeat itself, but it does rhyme."

There are many so called experts. I do not pretend to be one. The last two years have been an eye opener in revealing the ignorance of the so-called experts in the very subject they were deemed master of. The list of the so-called experts is too long.
Some great minds foresaw the unfolding of the subrime and financial crisis. These very few, were often derided. The list is too small.

What is interesting is that many of the so-called experts who were wrong, were wrong yesterday and the day before, are still wrong today. Yet they keep voicing their so-called expertise in the media.

On January 7, 1973, the New-York times featured an interview with Alan Greenspan, the future Federal Chairman urged investors to buy stocks without hesitation: "It's very rare that you can be as unqualifiedly bullish as you can now". 1973 and 1974 turned out to be some of the worst years for economic growth and the stock market since the Great Depression. From 1973 to 1974, US stocks lost 37%.

I could go on and on, about Mr Alan Greenspan expertise in creating bubble after bubble, refusing regulation and so forth, but this is not the subject of this post.

Can experts time the market any better than Alan Greenspan? No, most of the time.

As the wise Benjamin Graham told us, the intelligent investor must never forecast the future exclusively by extrapolating the past. But at least one need to study clearly the events and causes.

There have been some bold writers in the past:
To name a few:
Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market - (Oct 1999) by James K. Glassman and Kevin Hassett.
Dow 40000: Strategies for Profiting from the Greatest Bull Market in History by David Elias (Jun 1999).
DOW 40,000: The Stocks to Own to Outperform Today's Leading Benchmark by David Elias and Jeff Zabin (7 Nov 2001).

To be fair 1999 and early 2000, bull-market "baloney" was everywhere. Valuation did not count anymore, and the most dangerous sentence in the world was being used extensively: "It's different this time".

December 7, 1999:
Kevin Landis, portfolio manager of the Firsthand mutual funds on CNN Moneyline telecast about wireless telecommunication stocks being overvalued or not: "It's not mania", "Look at the outright growth, the absolute value of the growth. Its big".
January 18, 2000:
Robert Froelich, chief investment strategist at the Kemper Funds commented in the Wall Street Journal, "It's a new world order. We see people discard all the right companies with all the right people with the right vision because their stock price is too high-that's the worst mistake an investor can make".
April 10, 2000:
BusinessWeek, Jeffrey M. Applegate, then chief investment strategist at Lehman Brothers asked rethorically: "Is the stock market riskier today than two years ago simply because prices are higher? The answer is no."

Dow Jones at the time of Mr Applegate's comment was at 11,187, Nasdaq index was at 4,446. By the end of 2002, Dow was at around 8,300 level and Nasdaq around 1,300.

Source, The Intelligent Investor, revised edition, Commentary on Chapter 3.

On March 10, 2000, the very day Nasdaq hit the all time high Jim Cramer wrote he had been tempted to sell Berkshire Hattaway short: "ripe for the banging".
Warren Buffet during that period was derided for not participating in the Technology Boom and Bust.

Closer to us as well, many predicted that the subprime crisis in the summer of 2007 was a blip. Many commented that the sovereign crisis which erupted violently this year was contained following the bail out of Greece and the "wonderful" results of the Banks Stress Test.

Although market timing is extremely difficult, long macro trends as highlighted by the work of Angus Maddison are easier to spot. In a previous post about long term macro views, I pointed that long historical trends can give us at least a good insight into the development of specific regions. For instance, there is an ongoing redistribution of the World trade shares, from the West to the East. This evolution is a rebalancing act, not a new trend as indicated by the work of Angus Maddison. It is more a return to the mean for Asia.

Yes, history does rhyme as Mark Twain once quoted.

As well as understanding macro trends and data, it is of the utmost importance to study history as it often rhymes.
A great example in the use of history and strategic thinking can be attributed to the US General George S. Patton. General Patton had studied in depth ancient history and battles. It made him excel at predicting strategic moves.
On the 19th of December 1944, during the German Ardennes Offensive Eisenhower asked Patton how long it would take to turn his Third Army (located in northeastern France) north to counterattack . Patton answered he could attack with three divisions within 48 hours, to the disbelief of the other generals present. Before he had gone to the meeting, however, Patton had ordered his staff to prepare three contingency plans for a northward turn with at least three divisions strength.
Eisenhower: "When can you start?"
Patton: "As soon as you're through with me".
Eisenhower: "When can you attack?"
Patton: "The morning of December 21, with three divisions".
Eisenhower: "Don't be fatuous George. If you try to go that early, you won't have all three divisions ready and you'll go picemeal. You will start on the twenty-second and I want your initial blow to be a strong one! I'd even settle for the twenty-third if it takes that long to get three divisions."
Extract from Patton, A Genius for War, Carlos d'Este, published in 1996.

Carlos D'Este comments: "Eisenhower was dead wrong: It was not Patton the boastful but Patton the student of war at his absolute best."

Patton had studied history and knew where the next German offensive would come. Patton always demonstrated an extraordinary desire for information of all kinds. Combined with his knowledge of history and military tactics, three different plans were ready when the Ardennes offensive started. He was already expecting an offensive as early as the 25th of November 1944.

Back to the subject of macro trends and history, the current European crisis has not been resolved, not with Greece, not with Ireland.

One of the authors of "This time is different" (a must read...), Kenneth S. Rogoff clearly indicates that the Euro is only at Mid-Crisis in a very good article indicated below:

"Unfortunately, no. In fact, we are probably only at the mid-point of the crisis. To be sure, a huge, sustained burst of growth could still cure all of Europe’s debt problems – as it would anyone’s. But that halcyon scenario looks increasingly improbable. The endgame is far more likely to entail a wave of debt write-downs, similar to the one that finally wound up the Latin American debt crisis of the 1980’s."

Kenneth Rogoff brilliantly conclude this must read article by stating:

"As European policymakers seek to move from one stage of denial to another, perhaps it is time to start looking ahead more realistically. As any recovering alcoholic could tell them, the first step is admitting, with Merkel, that Europe has a problem."

I could not agree more. Following the credit binge which led to the current hangover, it is time for our European leaders to face the sobering facts and admit that they have been indeed addicted to cheap credit.
The Twelve-Step program for recovery from a credit addiction, as originally proposed by Alcoholics Anonymous (AA), involves the following:
-admitting that one cannot control one's addiction or compulsion;
-recognizing a greater power that can give strength;
-examining past errors with the help of a sponsor (experienced member);
-making amends for these errors;
-learning to live a new life with a new code of behavior;
-helping others that suffer from the same addictions or compulsions.

"Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it."
George Santayana (16 December 1863 – 26 September 1952)

No comments:

Post a Comment

View My Stats