``So we pour in data from the past to fuel the decision-making mechanism created by our models, be they linear or nonlinear. But therein lies the logician’s trap: past data from real life constitute a sequence of events rather than a set of independent observations, which is what the laws of probability demand.” Peter Bernstein
To our experience, there are two major common misperceptions of what drives the financial markets. In the case of the stockmarkets, the public generally believes that its directional path, in the absolute sense, is determined by either the conditions of the domestic economy or corporate earnings.
To question or to challenge such premises is almost equivalent to blasphemy; we get stared in the face with “shock and awe” kinesics with the implication that we either…come from another planet or…don’t know what we are talking about.
To be clear, like our contrarian view on the Peso, [see November 5 to November 9 edition What Media Didn’t Tell About the Peso], we do not dispute that the activities in the domestic economy and corporate earnings does somehow contribute to the pricing dynamics as evinced in the market ticker through the transmission of collective expectations, but our perspective is angled from the functions of correlation and causation in accordance to the conveyance of information from price signals.
As an example, as we recently cited, the popular view of the Philippine Peso’s strength has been constantly attributed by mainstream media to the grounds that strong inflows from remittances have “caused” its present conditions. While from the fundamental perspective such argument appears incontrovertible, however if one looks at the price trends of remittances relative to that of the Peso, we would find some notable divergences and belated correlations, all of which does not appear to demonstrate the straightforward cogency of such assertion. This is what distinguishes us from mainstream experts.
In the news you’d frequently read experts as saying or writing in simplified gist…“the market (stocks, commodities, bonds, real estate, labor, et. al.) has been moved by so and so factors (usually event-driven)”…or the extensive use of logical fallacies of post hoc ergo propter hoc (after this therefore because of this) or cum hoc ergo propter hoc (correlation does not imply causation). There are even experts who generally draw “cause and effects” conclusions to market outcomes by interposing their underlying biases on what they believe the market should be.
Dr. John Hussman of the Hussman Funds describes this phenomenon best (highlight ours),
``Unfortunately, most economists have never fully internalized the “rational expectations” view that market prices convey information. Of course, accepting this view does not require one to believe that prices convey information perfectly (which is what the efficient markets hypothesis assumes). But where finance economists take this information concept too far, economic forecasters don't take it far enough. As a result, economic forecasts are generally based on coincident indicators such as GDP growth and industrial production, or pathetically lagging indicators. This tendency to gauge economic prospects by looking backward is why economists failed to foresee the Great Depression and every recession since.”
Since market prices are mainly shaped by psychology through expectations which are transmitted by value judgments, the myriad flow of information impacts rightly or wrongly the decision making processes of diverse market participants in different degrees. As Ludwig von Mises in Human Action says…
``It is ultimately always the subjective value judgments of individuals that determine the formation of prices…. The concept of a "just" or "fair" price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.”
For instance, similar sets of information can be construed contrastingly by market participants which could prompt for opposite market actions.
A “buy the rumor sell the news” is concrete example, once a news comes out to either confirm or deny the rumors that impelled for the recent price movements, traders usually sell (acknowledging the end of the play) while investors buy (in confirmation of expectations), ergo value judgments actively at work in the marketplace.
In short, most of the mainstream analysis which feeds on the public’s “simplified” knowledge is predicated upon the “rear view mirror” syndrome or on recent past performances. Sometimes they also reflect on the biases of these experts.
Bottom line: When analyzing markets our proclivity is to read market signals and interpret them objectively instead of imposing our biases on our perceived market realities or subjecting them to selective analysis.
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