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All part of the analysis game

Date : 09/09/2009

Author:  Venkateshwaran Ramadoss

I am not trying to enact a Kahneman with this post, but I am trying to wonder, from what I do, see and hear, our susceptibility as analysts to errors driven by behavioral tenets. I have often been pointed out on my susceptibility to such follies and promptly guided out by my superiors, although it might not have happened all the time. Though no proud a claim it is, I have instances to console myself that they are prevalent in the market place and analysts, either amateur or seasoned, are equally susceptible for this part of the analysis game.

One of the analytics I found often used by many analysts during the current downturn is the technique of superimposing current price charts with those of the previous recessions from their respective peaks. A look at these charts now will tell you that apart from the fact that markets went down post the advent of crisis (what else will happen), nothing else can be inferred by such superimposing. As you see them, the current price line has displayed an entirely different shape and a great deal of creativity is needed to argue for similarity. However, when no one knew anything, this happened to be a wonderful tool of analysis accompanied by a great deal of discussions. Later on as markets bottomed up and as these charts started to divert, fading in terms of the appeal it once made, a different method was designed. This time the idea is to align all the lows and wonder the similarity in the way it bounced back (again, what else will happen initially if you align all lows). As it stands now, the chart again hardly provides any insights as some time has elapsed post the bottom and will slowly die in course in terms of its reference use. We can classify this tendency to more than one tenets proposed by behavioral economists.

David Rosenberg, Chief Economist and Strategist at Toronto-based wealth management firm, Gluskin Sheff + Associates, in his update on 2-Sep, argued to mean that the current fair value of S&P could be around 840-850.  Only at this level, he claimed, the market discounts a growth trajectory of 2%, which he considered appropriate. The reason being, the corporate debt market, which he is bullish about, discounts exactly the same growth rate.

"From a purely technical standpoint, which is beyond our purview but must be addressed since so much of the bear market rally was technically-based, a 50% retracement would imply a corrective phase to 840-850 on the S&P 500, which would imply that the market is back to pricing in a 2.0% growth trajectory for the coming year (precisely where the corporate bond market is in terms of its embedded outlook for growth)."

I got curious with this and went back to his archive postings to read what his stand was during July, when the S&P came closer to his equilibrium level. I found that he was as bearish about the stock market as he is today, albeit backed by a different set of arguments. As I couldn’t find any document in his archives to understand, I asked him what his stand was back during the March lows and he replied that he was “neutral” then. I wonder whether this is the classical “hindsight bias” on his part ,as this suggests either that he had not expected a 2% growth back then and their model was fed with much lower growth numbers compared to what it factors in now or he found c.93% annualized return opportunity to be not enough to compensate the risk!! Either way, it looks like he had turned bullish about the market but thinks that he had remained a bear all through. May be he is not and he could explain the “why not” better.

I have decided to have an eye for such instances and write about it in whatever mode possible. I am sure many of us will have such experiences and many more examples of such mistakes in the game of analysis and I would suggest we should all share them to play the game better.

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