Wednesday, May 11, 2005

It's NEVER Easy!

Every few days I read an article in the financial press telling me that the future direction of stock prices (or interest rates or the dollar or crude oil or gold or.......) is very uncertain. Usually the writer tries to tell me that this is an unusual situation. The typical excuse is that in these "unusual" times there are so many conflicting crosscurrents. The implication is that in "normal" times it is easy to guess what lies ahead of us in the future because most of the evidence will point one way or the other.

Let me tell you something. The future ALWAYS looks uncertain. To imagine it is ever otherwise is just plain dumb. Actually, there is a technical term for this sort of foolishness. It's called "hindsight bias". Hindsight bias is a particularly deadly disease when contracted by an amateur speculator.

You see, it always looks like it should have been easy to forecast past events. By the time history is written past events appear almost inevitable. We can always come up with good reasons why they happened. This process of explaining why past events happened I call "forecasting the past". You can read this sort of thing every day in the Wall Street Journal's daily stock market column.

Astologers, journalists and most market technicians like to forecast the past. Some are even good at it! Politicians often have some fun forecasting the past too. For example, they recently have been telling their constituents and the benighted intelligence community that it should have been obvious that Saddam Hussein had already destroyed his WMD and that any half-wit could have foreseen and detected the plans for the attacks upon the USA on 9/11.

Think about this for a second. If the future course of stock prices were obvious to most people, there would be no stock market! Why? Because if most people agreed that stock prices had to go up, who would be selling? A market requires a buyer for every seller!

An active and liquid market is absolutely rock-solid evidence that there is great uncertainty about the future and about its consequences for market prices. There has to be a lot of disagreement about the future in order to induce people to trade with one another!

The principal role of markets is to give anyone with capital and a stake in the future the opportunity to express his views by buying or selling. This process is called price discovery. The market always is looking for the price that will induce the most trading. And this is exactly the price that will induce the most uncertainty about future price trends!

So we must conclude that in any active and liquid market the future will always look very cloudy and uncertain to market participants. I have been forecasting stock prices for nearly forty years and don't remember a single day when future events seemed inevitable to me!

Uncertainty and confusion is the normal state of affairs in any active market. Dont' let anyone ever tell you otherwise.

1 comment:

The Assetman said...

Just wanted to let you know that I found the post to referenced to me very interesting. If you think about it, there's a whole industry devoted to "stirring the pot" with this uncertainty phenomenon.

The real question is whether this pot stirring being instigated brokerages is really all that "helpful". With enough market participants (especially given the growth of hedge funds), one would think that there would be plenty of friction without the help of ones making their living on commissions.

So do brokerages actually provide a useful service by "inducing" uncertainty? Or is there more efficient way that doesn't cause an inefficient transference of wealth?

I'm in total agreement with you on your premise. I just think what we see is overkill at times-- and for all the wrong reasons.