Not to show off or anything but one of my posts was picked up by Seeking Alpha. Interestingly, they had previously rejected a couple of my articles because they were too technical analysis-oriented. I guess contrarian investing isn't considered pure technical analysis and therefore is more palatable for publication. Anyhow, I'm not complaining, just musing.

Barron's Bashing, Part 267

I was going to do yet another post bashing Barron's and their kind of silly Roundtable. Then I came across Tim Kight's epic post about that very subject and he just nailed it! He even mentions Abby Joseph Cohen's new hairdo! A must read rant.

The only Roundtable participant whose picks actually made money last year, Fred Hickey makes a good point on gold. He said we haven't had a blow-off phase in gold as opposed to the other commodities. It's been an orderly bull for the last 8 years, so he thinks that there's more to go. He sees gold reaching $2,000 an ounce at some point.

Contrarian Investing: Pitfalls and Misconceptions

The old quip "Just because you're paranoid doesn't mean they're not out to get you", to which I'll add: "and even less that they won't get you" nicely illustrates a very common misconception when it comes to contrarian investing. In its simplified version, the misconception goes something like this: if a majority of people think something bad is going to happen then it won't happen.

On the face of it, this sounds ludicrous, doesn't it? And yet that is essentially what many market strategists have been saying for the past month in one form or another. They point out that an overwhelming majority of economists, various pundits, and now even our President-elect have been warning us that 2009 will be a disastrous year with rapidly rising unemployment, rapidly falling economic activity and more generally alarming statistics all around. This, the would-be contrarians contend, is proof enough that all the bad news have been discounted and that investors should position themselves, against the majority, for a better-than-expected 2009.

The problem with this line of reasoning is that its underlying assumption, essentially the folk version of Contrarian Theory, that most people are wrong most of the time is just plain wrong. Martin Pring, in his excellent Investment Psychology Explained, reminds us that the Theory of Contrary Opinion says that "the crowd (i.e. the majority of investors or traders) is actually correct most of the time; it is at turning points that they get things wrong". As any behavioral economist will tell you, accurately gauging the majority opinion is extremely difficult to start with. And even if one could correctly (and not only anecdotally) assess what the majority opinion actually was, "this knowledge [would] still result in frustration, because the crowd frequently moves to an extreme well ahead of an important market turning point". As John Schultz wrote in a 1997 Barron's article: "The guiding light of investment contrarianism is not that the majority view - the conventional, or received wisdom - is always wrong. Rather, it's that majority opinion tends to solidify into a dogma while its basic premises begin to lose their original validity and so become progressively more mispriced in the marketplace". In other words and to paraphrase Keynes, the crowd can stay irrational much longer than a trader can stay solvent.

The fact that so many people are making the contrarian argument that 2009 will be better than expected compounded with the fact that many things that are widely expected to go right could go very wrong, the most important of which, in my opinion, being the stimulus package (remember how it was supposed to be signed on Inauguration Day, then before February and now before March) lead me to be very wary of the contrarian bullish case. I don't doubt that the market could mount a few technical counter-trend rallies throughout the year but the idea of a sustained bullish move seems a little extravagant.

After being so wrong for so long, the majority opinion may unfortunately get this one right: 2009 may indeed be a very bad year.

The Farcical Swan

Decent article in the New York Times dealing with the shortcomings of Value at Risk. Nassim Taleb is frequently quoted but does not come out as well as the other more measured and cogent experts consulted for the article.

I think the problem with Taleb is that he pushed a good concept (the Black Swan) to its farcical extreme (which incidently is exactly what happened with VaR). Nothing illustrates that better than when he says: “Any system susceptible to a black swan will eventually blow up”.The problem with this statement is that most of the systems we use and live in are susceptible to a black swan (a meteor could hit us, a nuclear bomb could go off, etc...). So what are we supposed to do, never take another risk, never plan another project, hide in a cave and pray?

And how about positive black swans (which Taleb talks about in his books but seems to have forgotten lately)? In trying to avoid negative black swans, we may also deprive ourselves of potential positive black swans and a missed positive black swan can be just as costly as a realized negative one.

The Aftermath

No, not the Dr. Dre classic but a great NBER paper titled The Aftermath of Financial Crises that goes over about 20 historical examples of banking crises to try and chart the course of the next few years. The surprising thing is that, historically, the outcome of each major financial crisis has been pretty homogeneous worldwide and there is no reason to believe this time will be different. As the authors nicely put it in their conclusion, "one would be wise not to push too far the conceit that we are smarter than our predecessors".

Basically here's what we should expect (the averages for the historical comparison group):

- A real housing price decline of 35% with a downturn lasting about six years.
- An equity price decline of 55%, downturn lasting three and a half years.
- A rise of 7% in the unemployment rate over a 4-year employment downtrend.
- A GDP fall of over 9% over a 2-year downtrend.
- An explosion in the real value of government debt of 86% due, not to bailouts, but to the collapse in tax revenues and countercyclical fiscal policies.

And this, it would seem, no matter what our good friends in Washington concoct for us.

Randomness and Quackery

Many people equate random with non-predictable and reflexively consider anyone claiming to have an insight into future prices a quack.

However, it has never been demonstrated that prices can never be predicted, only that they can't be easily predicted, all the time. It kind of makes sense to me that there are some windows of opportunity where prices are easier to predict than others. Talented traders/analysts will find more of those windows of opportunity and profit more from them than less talented ones.

Deflation begets Inflation

Interesting 2009 forecast on the Accrued Interest blog. He doesn't see any inflation in 2009 since the Fed will be spending most of the year fighting deflation. However, "to suggest that the Fed will provide just enough stimulus to avoid deflation but not create a significant inflation problem down the road is ridiculous".

This is the important point: the harder the Fed fights deflation (and it's a given at this point that "there will be no limit as to how far the Fed goes to fight deflation") the more certain a nasty bout of inflation awaits us when the cycle turns.

Laszlo Birinyi, Technical Analyst

Barron's:

" You put out a piece in 1996 asserting that technical analysis had failed. What's your stance on that today?"

Laszlo Birinyi:

" A lot people (sic) think I'm really anti-technical analysis but I'm really anti-technical analysts.Analysis of the stock market really should be somewhat comparable to a physical where you spend as much time diagnosing as you do prescribing. I find that too many technicians prescribe and really don't try to understand what they are looking at. I also find that a lot of technical indicators are not predictive. For example, an advance-decline line tells you that a lot of stocks are going down but it doesn't necessarily tell you about what's going to happen."

I feel the only adjective that does this justice is: lame. In my book, what Mr. Birinyi does IS technical analysis which makes him a technical analyst, though obviously a self-hating technical analyst.