EM Guru Mark Mobius Flip Flops Anew: EM Sell Off Nears End

One of the costs of wildly fluctuating markets has been to expose on the confusions of experts, who try to preserve their public image.

For example I noted that EM guru cheerleader Mark Mobius, who claimed at the start of the year that EM outflows will turn into inflows, suddenly made a volte face last week to predict that EM outflows will “deepen”. This call was made when markets had been going on the opposite direction of his early forecasts.

Now that EM financial markets have shifted from Risk OFF to Risk ON, Mr. Mobius changes his mind for the second time over the past two weeks.

From Bloomberg:

The selloff that triggered the worst start for emerging-market stocks in four years is approaching the end as valuations begin to look attractive, Templeton Emerging Markets Group’s Mark Mobius said.

“We are nearing the point where people are beginning to say ‘hey, it looks pretty good now in terms of valuations,’” Mobius, who oversees more than $50 billion in developing-nation assets as an executive chairman at Templeton, said in an interview on Bloomberg Radio today. “We are probably nearing the end of this big rush out of emerging markets.”

The comments mark a shift in sentiment for Mobius, 77, who said on Feb. 7 that developing nations could “expect a lot more selling.”

The issue of “pretty good now in terms of valuations” depends on how one sees the current environment. 

In my view, when EM economies are facing weak currencies, increasing CPIs and higher bond yields (indicative of higher interest rates) amidst elevated debt levels, then accordingly this means a shift in the valuations landscape as the same factors will not only alter the profit environment, they will also have an impact on consumer demand, credit conditions and credit quality and the supply side growth. If such a shift will be disorderly then this may even lead to a drastic change in the political environment that could also impact again valuations.

In short, a benign environment from zero bound rates and a convulsing environment, which are symptoms of resistance to change against rising rates amidst high debt levels, will extrapolate to apples and oranges comparison. Thus failure to understand such transition would lead to confusions.

And because fund managers earn from varied fees (e.g. Franklin Templeton) from their investor’s portfolio it is understandable for them to promote their interests. Talking down the fund's investment themes may lead to investor withdrawals thus reducing fund fees.

The point of this exercise is not to disparage any experts, particularly on Mr. Mobius whom I respect, but to show of how sharply gyrating markets entwined with industry interests seem to have led some experts to vacillate on their forecasts.

Quote of the Day: The Illusions of Pundits

People who spend their time, earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options. Even in the region they knew best, experts were not significantly better than non-specialists.

Those who know more forecast very slightly better than those who know less. But those with the most knowledge are often less reliable. The reason is that the person who acquires more knowledge develops an enhanced illusion of her skill and becomes unrealistically overconfident. “We reach the point of diminishing marginal predictive returns for knowledge disconcertingly quick,” Tetlock writes. (Philip E. Tetlock, University of Pennsylvania in 2005 book Expert Political Judgment: How Good is It? How Can We Know?—Prudent Investor) “In this age of academic hyperspecialization, there is no reason for supposing that contributors to top journals—distinguished political scientists, area study specialists, economists, and so on—are better than journalists or attentive readers of the The New York Times in ‘reading’ emerging situations”. The more famous of the forecaster, Tetlock discovered, the more flamboyant the forecasts. “Experts in demand,” he writes, “were more confident than their colleagues who eked out existences far from the limelight.”

The above quote is from 2002 Nobel laureate psychologist and professor Daniel Kahneman in his insightful book Thinking, Fast and Slow p.219

There are many reasons not to trust pundits, aside from overconfidence, which essentially oversimplifies human action.

I believe that the substantial chunk of “expert errors” emerge from the influences of conflict-of-interest relations, particularly the principal-agent problem, where “experts” tend to promote the interests of employers, sponsors, donors, grant providers and or even political agents (perhaps through implicit ambition to be part of the political institution) whom are sources of the self-interests of such pundits.

Forecasting inaccuracies may also be linked to the rigid application of ideology and or on the overreliance on math models (scientism).

Add to this the desperate desire by “experts” to attain social acceptance via social signaling.  Such would include making extreme (media attracting) projections or providing the veneer of expertise on what truly is about populism—forecasting based on what is popular, or as I previously wrote 

For many, thus, expertise signify more as social signaling (posturing or seeking social acceptance) and or “telling people what they want to hear” but predicated on certain technically based paradigms which produces an aura of supposed superiority rather than representative of the true domain knowledge.

Dr. Kahneman suggests that to determine “true expertise” from merely displays of the “illusions of validity”, one should identify conditions where pundits have excelled in “an environment that is sufficiently regular to be predictable” and from their having “to learn these regularities through prolonged practice” (p 240). In short, in an unpredictable world, expert opinion should be less trusted.

However by simply associating expertise with “regularity” and “prolonged practice” seems to contradict logically his earlier critique of pattern seeking behavior (which is about the human psychological propensity to seek regularity or constancy through patterns while at the same time underestimating the role of randomness). The nuance will be on the marginal efforts applied by practitioners via  “prolonged practice” in dealing with such regularities. 

The point is despite being able to minimize the influences of “expert or non-expert” intuition on decision making that may result to lesser degree of judgmental errors, behavioral economics/finance will not lead to omniscience or come close to solving the knowledge problem: a complex society will always be subject to irregularities and unpredictability from the dynamic and intricate feedback mechanism of human action and of environmental changes. Dr. Kahneman acknowledges this: "Errors of prediction are inevitable, because the world is unpredictable" (p. 220)

Nevertheless the best way to acquire “expertise” is primarily through investing in oneself

Dr. Marc Faber Warns of 1987 Crash if No QE 3.0

From Bloomberg,

U.S. stocks may plunge in the second half of the year “like in 1987” if the Standard & Poor’s 500 Index (SPX) climbs without further stimulus from the Federal Reserve, said Marc Faber, whose prediction of a February selloff in global equities never materialized.

“I think the market will have difficulties to move up strongly unless we have a massive QE3,” Faber, who manages $300 million at Marc Faber Ltd., told Betty Liu on Bloomberg Television’s “In the Loop” from Zurich today, referring to a third round of large-scale asset purchases by the Fed. “If it moves and makes a high above 1,422, the second half of the year could witness a crash, like in 1987.”

The Dow Jones Industrial Average plunged 23 percent on Oct. 19, 1987 in the biggest crash since 1914, triggering losses in stock-market values around the world. The Standard & Poor’s 500 Index plummeted 20 percent. The Dow still closed 2.3 percent higher in 1987, and the S&P 500 advanced 2 percent.
“If the market makes a new high, it will be a new high with very few stocks pushing up and the majority of stocks having already rolled over,” Faber said. “The earnings outlook is not particularly good because most economies in the world are slowing down.”

Profit Growth

More than 69 percent of companies the S&P 500 that reported results since April 10 have exceeded analysts’ forecasts for per-share earnings, according to data compiled by Bloomberg. Profits are due to increase 3.9 percent in the second quarter and 6 percent the following period, estimates compiled by Bloomberg show.

Faber said a third round of quantitative easing would “definitely occur” if the S&P 500 dropped another 100 to 150 points. If it bounces back to 1,400, he said, the Fed will probably wait to see how the economy develops.

see Bloomberg's interview of Dr. Marc Faber below

Media has the innate tendency of reducing investment gurus into astrologers or soothsayers by soliciting predictions over the short term. And investing gurus eager to gain media limelight fall into their trap. And this is why Dr. Faber’s warnings comes with a Bloomberg notice about his latest failed predictions, which has been punctuated by "whose prediction of a February selloff in global equities never materialized."

Dr. Faber, who introduced me to the Austrian school of economics through his writings, is simply stating that if a tsunami of central banking money has been responsible for the buoyant state of markets, then a withdrawal of which should mean lower asset prices. In short, the state of the financial markets heavily, if not almost totally, relies on the actions of central bankers.

Yet since we can’t entirely predict the timing and the degree of central bank interventions, or if they intervene at all, we should expect markets to be highly sensitive to excessive volatility.

And aside from money printing, the risk of high volatility has been amplified by many other interventions on the marketplace (via various bank and financial market regulations). And heightened volatility could translate to a crash. And don’t forget a crash could be used to justify QE 3.0.

As to whether the Fed’s QE 3.0 will come before or after a substantial market move is also beyond our knowledge, since this will depend on the actions of political authorities. I have to admit I can’t read the minds of central bankers.

Yet QE 3.0 may come yet in the form of actions of other central bankers, e.g. ECB’s LTRO and or SMP.

What I know is that inflationism has been seen by the mainstream and by the incumbent political authorities as very crucial for the survival of the current forms of political institutions. This is why I, or perhaps Dr. Faber, sees the probability for more central bank interventions over the marketplace. This is because the cost of non-intervention would be a substantial reduction of the political control over society from vastly impaired political institutions.

It must be noted that Austrian economics is basically an explanatory science, where given a set of actions we see the consequence being such or such. The idea of reducing logical deduction into some form of predictive science is wizardry.

In short, while I don't predict a crash I would not rule out this option. Especially not in a highly distorted and politicized markets

Why the Austrian Business Cycle is Not a Tarot Card

Many, if not most people, tend to look for a one-size-fits-all solution or supposed elixirs to the world’s problem. That’s one of the key reason why many are seduced by analysis or reasoning premised on mathematical or statistical models or on pattern seeking formulas.

Readers of this blog recognize that I use much of the Austrian Business Cycle Theory (ABCT), but not as a standalone way to evaluate markets and events. It is important to know of the limitations of every theory, and this applies to the ABCT as well.

Professor Steve Horwitz explains, (italics original, bold emphasis mine)

Both critics and adherents of the ABCT misunderstand it if they think it is some sort of comprehensive theory of the boom, breaking point, and length/depth of the bust. It isn't. As Roger Garrison has long insisted, the theory by itself is a theory of the unsustainable boom. It is a theory that explains why driving the market rate of interest below the natural rate through expansionary monetary policy produces a boom that contains endogenous processes that will cause that boom to turn to a bust. Again, it's a theory of the unsustainable boom.

ABCT tells us nothing about exactly when the boom will break and the precise factors that will cause it. The theory claims that eventually costs will rise in such a way that make it clear that the longer-term production processes falsely induced by the boom will not be profitable, leading to their abandonment. But it says nothing about which projects will be undertaken in which markets and which costs (other than perhaps the loan rate) will rise, and it tells us nothing about the timing of those events. We know it has to happen, but the where and when are unique, not typical, features of business cycles.

Once the turning point is reached, ABCT tells us little to nothing about how the bust will play out. Yes, we know that further inflation and interventionist attempts to prevent the necessary reallocation of resources will make matters worse, but the theory by itself doesn't tell us a priori how this will play out in any given historical circumstance. The ABCT is not a theory of the causes of the length and depth of recessions/depressions, but a theory of the unsustainable boom.

In short, the ABCT explains the cause and effects of tampering with interest rates. Yet there are many other influences to people's incentives to act, which is not limited to interest rate signals.

And in looking for specifics or exactitudes, like ‘timing’ and which ‘particular projects or costs’ will be affected, would be similar to looking for answers from the tarot card. Obviously ABCT does not work that way.

Video: Predictive Value of Austrian Economics versus Keynesian Economics

To kick off my vacation blogging, the following video shows of the predictive value of Austrian Economics versus mainstream mostly Keynesian economics (hat tip Bob Wenzel).

Notice the intense pressures Austrians face when confronted by usually hostile mainstream crowd. I know how this feels.

And this is where Mahatma Ganhi's rule applies

First they ignore you, then they laugh at you, then they fight you, then you win

Quote of the Day: Financial Markets will Never Be an Exact Science

The factors that determine activity on the Exchange are innumerable, with events, current or expected, often bearing no apparent relation to price variation. Beside the somewhat natural causes for variation come artificial causes: The Exchange reacts to itself, and the current trading is a function, not only of prior trading, but also of its relationship to the rest of the market. The determination of this activity depends on an infinite number of factors: It is thus impossible to hope for mathematical forecasting. Contradictory opinion about these variations are so evenly divided that at the same instant buyers expect a rise and sellers expect a fall.

The calculus of probability can doubtless never be applied to market activity, and the dynamics of the Exchange will never be an exact science. But it is possible to study mathematically the state of the market at a given instant—that is to say, to establish the laws of probability for price variation that the market at that instant dictates. If the market, in effect, does not predict in fluctuations, it does assess them as being more or less likely, and this likelihood can be evaluated mathematically.

That’s from the opening lines of “Theorie de la Spéculation” by 20th century French Mathematician Louis Bachalier (1870-1946). Mr Bachalier has been credited with being the first person to model the stochastic process now called Brownian motion, which was part of his PhD thesis The Theory of Speculation, (published 1900). [Wikipedia.org]

Source: Benoit B. Mandelbrot and Richard L. Hudson, The (Mis) Behaviour of Markets p.51

IMF Predicts The End of the “Age of America” in 2016

From the Marketwatch,

The International Monetary Fund has just dropped a bombshell, and nobody noticed.

For the first time, the international organization has set a date for the moment when the “Age of America” will end and the U.S. economy will be overtaken by that of China.

And it’s a lot closer than you may think.

According to the latest IMF official forecasts, China’s economy will surpass that of America in real terms in 2016 — just five years from now.

Put that in your calendar.

It provides a painful context for the budget wrangling taking place in Washington right now. It raises enormous questions about what the international security system is going to look like in just a handful of years. And it casts a deepening cloud over both the U.S. dollar and the giant Treasury market, which have been propped up for decades by their privileged status as the liabilities of the world’s hegemonic power...

Naturally, all forecasts are fallible. Time and chance happen to them all. The actual date when China surpasses the U.S. might come even earlier than the IMF predicts, or somewhat later. If the great Chinese juggernaut blows a tire, as a growing number fear it might, it could even delay things by several years. But the outcome is scarcely in doubt.

This is more than a statistical story. It is the end of the Age of America. As a bond strategist in Europe told me two weeks ago, “We are witnessing the end of America’s economic hegemony.”

We have lived in a world dominated by the U.S. for so long that there is no longer anyone alive who remembers anything else. America overtook Great Britain as the world’s leading economic power in the 1890s and never looked back.

Well that indeed is a bold prediction coming from the multilateral institution which failed to predict the emergence of the 2008 financial crisis.

IMF’s over reliance on econometric models makes them greatly dependent on constants as basis for their predictions. Constants do not exist in the world of human action and even in the environment (e.g. Japan’s science models failed to predict the last disaster).

In addition constant based models tend to generate linear progressions which means that methodological calculations greatly depends on data from past performances, thus subjecting them to flagrant errors from black swan ‘fat tail’ events.

I’d say that this supposed end of the “age of America” and the contemporaneous "rise of China" strongly depends on some major interrelated factors: bubble cycles, inflationism, the political resolution of the grand unwieldy fiscal deficits, state of economic freedom, and the progress of technological innovation and the scale of transition of the global economy to the information age.

Say for instance, if China’s bubble does unravel before 2016, then the IMF’s clock could suffer a substantial reversal.

To reminisce, many saw Japan as a contender to the US crown in the 1980s. Events turned out that the much heralded Japan Incorporated had been an illusion of prosperity and success brought about by funny money. Events could turn out the same for China. I am not saying it will, but it could.

Also, policies that “kick the can down the road” via inflationism may increase the fat tail risk of hyperinflation for the US, or even for the rest of the world if everyone embraces competitive devaluation as a common national monetary policy.

In other words, predicting the end of the Age of America is not going to be that simple. IMF should predict first, NOW before the Presidential primary, who will be the President of the US in 2012.

Events are as fluid as people adapt and respond to social and environmental changes.

Always A Bull Market Somewhere

Some of the nattering nabobs of doom have resurfaced.

They argue that the present weakness in the markets signify as signs of the next market meltdown.

These people seem to argue not from evidence but from dogma.

And people blinded by dogma tend to get market predictions utterly and consistently wrong.

Even if they are correct and that a market meltdown occurs, it isn’t likely the same scenario as 2008.

We must be reminded that despite ANY market condition “there always will be a bull market somewhere”. The intrinsic difference is one of the idiosyncratic operating conditions which produces diverse types of bullmarkets.

In the 2008, despite a general financial market meltdown brought about by the recession that culminated with the Lehman collapse, the bullmarket was seen in the US dollar and US treasuries.

chart from netdania

Yet the same experts who failed to see the recent rallies and have made the Great Depression as the fount of their predictions seem to be singing the same tune again.

The idea of a Great Depression circa 2011 is false for the simple reason past conditions are patently dissimilar from today.

True, the US stock markets had its first major episode of correction for the year 2011.

But was it a broad market meltdown?

From US Global Investors

Obviously not.

The energy sector defied last week’s downturn. This goes to show that there has been an ongoing rotation of money—all too symptomatic of inflation dynamics at work.

As it is rare to find this gem of reality check from the mainstream; from the Wall Street Journal

It's important to keep in mind, however, that oil was already trading in the $85 to $90 a barrel range before the recent irruption in the Arab world. The run-up to that price territory began in earnest last year after the Federal Reserve embarked on its QE2 strategy of further monetary easing.

The Fed absolves itself of any responsibility for rising oil prices, attributing them to rising demand from a recovering global economy. Demand has been rising, but not enough to explain what has been a nearly across-the-board spike in prices for dollar-traded commodities. (Natural gas is the big exception, thanks to a boom in domestic exploration.) A spike in one or two commodities can be explained by a change in relative demand. A uniform price spike suggests at least in part a monetary explanation. The Fed will use the Libya turmoil as another alibi, but there's no doubt in our mind that oil prices include a substantial Ben Bernanke premium.

We have been told by most media outlets except the above that rising oil prices represent as a supply shock.

However, even if the Middle East Crisis fizzles out you’d be surprise to see that after the Libya premium would have been covered, oil prices will continually rise and will exceed the last highs and approach the $200 as we have been predicting.

chart from Pragmatic Capitalism

Of course we don’t believe that it’s a bear market, not yet anyway.

What we may be seeing instead could be another bubble at work in the US equity markets as margin trade in the US have been ballooning.

So people who argue that cash should be king will likely be wrong again.

Not with more chatters of QE 3.0 or where global governments have been deliberately destroying the purchasing power of money or currency values. And certainly not when the adjusted monetary base which is one of the monetary component which the Federal Reserve controls.

From St. Louis Fed

At the end of the day, all these money will have to flow somewhere. And unless governments learn to restrain themselves the likelihood is that we would likely see higher commodity prices—food, gold, oil etc....

As a side note fiat money stands for political redistribution, and similarly shackles to freedom and liberty. Meanwhile gold stands for the opposite, as per Ralph Waldo Emerson, “The desire for gold is not for gold. It is for the means of freedom and benefit”. Do not confuse one for the other.

Beware Of Economists Bearing Predictions From Models

Max Borders explains (emphasis added)

"So what do all these macroeconomic models have in common?

-They’re rendered either in impenetrable math or with sophisticated computers, requiring a lot of popular (and political) faith.

-Politicians and policy wizards hide behind this impenetrability, both to evade public scrutiny and to secure their status as elites.

-Models vaguely resemble the real-world phenomena they’re meant to explain but often fail to track with reality when the evidence comes in.

-They’re meant to model complex systems, but such systems resist modeling. Complexity makes things inherently hard to predict and forecast.

-They’re used by people who fancy themselves planners—not just predictors or describers—of complex phenomena."

The point is, according to Richard Ebeling, ``The inability of the economics profession to grasp the mainsprings of human action has resulted from the adoption of economic models totally outside of reality. In the models put forth as explanations of market phenomena, equilibrium — that point at which all market activities come to rest and all market participants possess perfect knowledge with unchanging tastes and preferences — has become the cornerstone of most economic theory."

Yet many people stubbornly refuse to learn from the lessons of the last crisis.

The mainstream hardly saw the last crisis from ever occurring:

This is why the Queen of England in 2009 censured the profession's failure to anticipate the crisis.

This also why US investment banks became an extinct species in 2008 as remnant banks were converted into holding companies, as losses strained the industry's balance sheets, which forced these banks into the government's arms.

This also why Ponzi artist Bernard Madoff gypped, not only gullible wealthy individuals but importantly a slew of international financial companies.

And this is also why contrarian John Paulson was able to capitalize on shorting the housing bubble via Goldman Sachs, which became a recent controversy, because the other side of the trade had been 'sophisticated' financial companies.

In retrospect, not only was the mainstream composed of highly specialized institutions, which were not only model oriented, but had an organization composed of an army of experts that have not seen, anticipated, predicted or expected these adverse events.

It is also important to point out that not only are the models unrealistic but those making these models are people with the same frailties whom they attempt to model. These people are also subject to the same biases that helped skew the models, which they try to oversimplify or see constancy in a dynamic world. They are also subject to Groupthink and the influences of Dopamine in their decision making process.

Adds Mr. Borders, (emphasis added)

``What does this mean for economics as a discipline? I think it’s time we admit many economists are just soothsayers. They keep their jobs for a host of reasons that have less to do with accuracy and more to do with politics and obscurantism. Indeed, where do you find them but in bureaucracies—those great shelters from reality’s storms? Governments and universities are places where big brains go to be grand and weave speculative webs for the benefit of the few.

``And yet “ideas have consequences.” Bureaucracies are power centers. So we have a big job ahead of us. We’ve got to do a seemingly contradictory thing and make the very idea of complex systems simple. How best to say it? Economists aren’t oracles? Soothsaying is not science? Ecosystems can’t be designed?

“The very term ‘model’ is a pretentious borrowing of the architect’s or engineer’s replica, down-to-scale of something physical,” says Barron’s economics editor, Gene Epstein. “These are not models at all, but just equations that link various numbers, maybe occasionally shedding light, but often not.”

Bottom line: Incentives and stakeholdings largely determine the mainstream's fixation to models.

Many are driven by ego (desire to be seen as superior to the rest), others are driven by politics (use math models to justify securing the interests of particular groups), some by groupthink (the need to be seen in the comfort of crowds), some because of personal benefits (defense of political or academic career, stakeholdings in institutions or markets or businesses) and possibly others just for the plain obsession to mathematical formalism.

At the end of the day, logic and sound reasoning prevails.

Analyzing Predictions

“I’ve been dealing with these big mathematical models of forecasting the economy…I’ve been in the forecasting business for 50 years…I’m no better than I ever was, and nobody else is. Forecasting 50 years ago was as good or as bad as it is today. And the reason is that human nature hasn’t changed. We can’t improve ourselves.” Alan Greenspan

Baseball legend Yogi Berra once quipped on a sarcastic irony on prediction, ``Prediction is very difficult, especially if it's about the future."

Nevertheless prediction has been hardwired into the mankind’s genes with the implicit goal to overcome risks in order to ensure existential continuity of the specie. As Peter Bernstein aptly wrote in Against The Gods, ``The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk…”

Predictions From A Historian’s Perspective

Well, prediction is a tricky business. Since the advancement of science, the scientific model (quantitative) approach has been frequently utilized to determine probabilistic outcomes given defined set of variables.

However, social science appear to be more complex than anticipated, given that people have different scale of values, which are likewise meaningfully influenced by the divergences in time preferences, and also influenced by sundry cognitive biases, which subsequently makes us respond differently even to the same set of conditions.

As mathematician and scientist Professor Benoit Mandelbrot of the Fractal Geometry fame said in a PBS News Hour Interview, ``The basis of weather forecasting is looking from the satellite and seeing the storm coming but not predicting that the storm will form, the behavior of economic phenomenon is far more complicated than the behavior of liquid and gasses” (underscore mine)

Since markets are essentially economic events, the complications is that they represent endemically a menagerie of action-reaction and stimulus-response feedback loop dynamics to which Professor Mandelbroit elucidated in The (Mis)Behaviour Of Markets as, ``prices are determined by endogenous effects peculiar to the inner workings of the markets themselves, rather than solely by the exogenous actions of outside events.”

So given that markets signify more of human action dynamics than the functional state of natural science then our choice in making predictions will be one similar to the work of historians. Murray N. Rothbard makes the appropriate analogy, ``The latter attempts to "predict" the events of the past by explaining their antecedent causes; similarly, the forecaster attempts to predict the events of the future on the basis of present and past events already known. He uses all his nomothetic knowledge, economic, political, military, psychological, and technological; but at best his work is an art rather than an exact science. Thus, some forecasters will inevitably be better than others, and the superior forecasters will make the more successful entrepreneurs, speculators, generals, and bettors on elections or football games.” (all bold underscore mine)

The point is: Markets are likely to exhibit the causal effects from precursory human actions than from math designed economic models that ignore the aspects of human decision making.

Unfortunately the mainstream appears addicted to apply models even if they’ve been proven to be repeatedly unrealistic, either for reputational (need to be seen as pedagogic) or for social affiliations (need to be seen talking the same language) motivations or due to ideological blindspots (dogmatic treatment of economic theories).

Predictions Based On Dumb Luck

Besides, predictions should be weighed from the angles of opportunity costs and the incentives of the forecaster’s standpoint.

When a forecast for a certain direction of the market is unfulfilled, but at worst, goes into substantially to the opposite direction, losses will be real for those who adhered to them.

For instance, many ‘experts’ who predicted the “crash of the stock market” in 2009, when the market soared anywhere from 20-50% based on G-7 and BRIC and key emerging markets, could have bled their customers dry or would have lost 20-50% in profit opportunities from such erroneous predictions.

Yet for them to bluster “I told you so!” because the markets sizably fell this week would signify as “even a broken clock is right twice a day”! This implies that they’ve been right for the wrong reasons or as indicated by Urban Dictionary “success obtained through dumb luck”.

Market predictions shouldn’t translate to an immediate or outright fulfillment but instead focus on mitigating risks and optimizing profits. When markets move violently against a touted position and the forecaster refuses to badge, then it isn’t about “mitigating risks and optimizing profits” nor is it about accuracy, but about being foolishly arrogant or about obstinately adhering to wrong analytical models.

Remember since markets move in only two directions (up or down)… they are going to be right somehow.

Nevertheless successful investing isn’t myopically about being theoretically right or wrong but about generating maximum profits from the right moves and reducing losses on the wrong moves.

Since as human beings we are susceptible to mundane lapses, then investing is about dealing with the magnitude or the scalability of the portfolio and not of the frequency of transactions. In addition, it is also about the allocative distribution of a portfolio pertinent to perceived risks conditions.

Furthermore, as we said in Reasons To Distrust Mainstream Economists, some forecasters have different incentives for making publicly based predictions.

Some are there for mere publicity purposes (celebrity guru such as Nouriel Roubini makes the spotlight anew with another wondrous shift by predicting a market meltdown in the 2^nd half! It’s amazing how media glorifies an expert whose calls have been repeatedly off tangent) or to promote certain agenda- e.g. promote political interventions-example Bill Gross [see Poker Bluffing Booby Traps: PIMCO And The PIIGS], sell newsletters, sell funds, etc...

For instance, some experts recently argued that the recent wobbles in Wall Street validates the state of the economy. Does this translate that markets only reflect on reality on when they conform to the directions advocated by these so-called “seers”? That would be utter crock.

The truth is that the current state of the global economy operates under a fiat money regime which perpetuate on the boom bust cycles, irrespective of the actions by regulators to curtail private greed but not on their actions-which have been the underlying cause of it.

Put bluntly, politically oriented boom bust cycles are the dominant and governing themes for both the global markets and the world economy. Therefore, market actions on both directions have been revealing these dynamics.

They don’t essentially validate or invalidate the workings of the economy, because they are `` endogenous effects peculiar to the inner workings of the markets themselves, rather than solely by the exogenous actions of outside events” as Professor Mandelbroit would argue.

Hence, the “desperately seeking normal” school of thought represents as a daft pursuit to resurrect old paradigms under UNSUPPORTIVE conditions- we don’t use radar to locate for submarines or any underwater objects!

Similarly ludicrous is to show comparative charts of the crash of 1929 as a seeming parallel for today’s prospective outcome. This is a brazen example of the cognitive bias known as the “clustering illusions” or seeking patterns where there is none.

Unfortunately, even professionals fall for such lunacy, which is emblematic of why mainstream analysis should be distrusted [see earlier discussion in Why Investor Irrationality Does Not Solely Account For Bubble Cycles].

These people fundamentally forget that 1920s operated on a GOLD STANDARD while today’s world has been on a de facto US dollar standard. Today we have deposit insurance when in 1929 crash we didn’t.

Today is the age of the internet or Web 2.0, where communications have advanced such that they are done by email, or conducted real time as voice mail, web based conferencing, digital cameras, iPods and etc., and where the cost to do business has substantially fallen to near zero and which has, consequently, attracted the scalability of globalization.

In the 1920s, communications were in a primal mode: stamped postal mails, the electrical telegraphs, manual based switchboard rotary telephones, and photography were based on celluloid film 35mm Leitz cameras. All these were emblematic that the 1920s had operated on an agro-industrial age.

Today we have niche or specialized markets when in the 1900s it was all about mass marketing. These are just a few of the major outstanding differences.

In short, the fact that the basic operating framework of the political economy has been disparate implies that the effects to the markets would be equally distinct. Think of it, fundamentally speaking, monetary policies in the pre Bretton Woods 1900s were restricted to the amount of gold held in a country’s reserves while today central banks have unrestrained capacity for currency issuance.

Columbia Business School’s Charles Calomiris makes this very important policy-market response feedback loop differentiation in an interview,

``From 1874 to 1913, there was a lot of globalization. But worldwide there were only 4 big banking crises…From 1978 to now, there have been 140 big banking crises, defined the same way as the earlier ones: total losses of banks in a country equalling or greater than 10% of GDP.” (bold highlights mine)

As you would notice, the emergence and proliferation of central banking coincided with the repeated and stressful occurrences of big banking crisis. Put differently, where central banking fiat currency replaced the gold the standard, banking crisis became a common feature. So to argue that market actions don’t reflect reality translates to a monumental incomprehension or misinterpretation of facts and theory.

Yet if markets should reflect on the same 1929 dynamics, this would be more the mechanics of dumb luck than representative of economic reality. Besides, to presuppose as engaging in “economic” analysis to support such outlandish theories, but without taking to account on these dissimilarities, would also signify as chimerical gibberish or pretentious knowledge.

Bottom line: I’d be careful about heeding on the predictions of the so-called experts, where I would read between the lines of interests of these forecasters, their way of interpreting facts and the theory used, aside from opportunity costs from lapses, and their forthrightness.

Yet, I’d pay heed to Benjamin Graham, the father of value investing when he admonished, ``If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market."

Wall St. Cheat Sheet: Nouriel Roubini Unmasked; Lessons

The following article, from Wall St. Cheat Sheet, scoffs at the track record of high profile economist Nouriel Roubini in making predictions.

According to Wall St. Cheat Sheet:

``In August I wrote an article “Is Nouriel Roubini a False Prophet?” Apparently, some people are so smitten with Roubini they actually ignored all the cited articles and said, “No.” Consequently, I teamed up with a bunch of people around the world on an open source project to continue our mission exposing false prophets and help unwash those well-meaning brains

``The following video is a large collection of evidence proving Roubini has a horrendous record as a prognosticator. If you too know someone who has been listening to the seductive sounds of Roubini’s mantras, send them this helpful deprogramming message:

Normally, such take downs usually won't make my post. However, there are lessons to be gleaned from this critique which necessitates some discussion.

1. The Role of Media. This reveals of the proclivity of media to glamourize personalities who glibly "represent" the Du jour issues regardless of their past performance.

The appearance of fluency, urgency and connectivity to current events translates to more coverage. Ergo, the celebrity status.

2. Expert problem. Nassim Taleb says that "intelligent or informed persons were at no advantage over cabdrivers" in making predictions.

Why? Because of egotistical problem. Again according to Mr. Taleb, ``The problem with experts is that they do not know what they do not know. Lack of knowledge and the delusion about the quality of your knowledge come together-the same process that makes you know less also makes you satisfied." (emphasis added)

In short, experts tend to confine themselves on what they know.

3. Knowledge problem. There is also the tendency for experts to lean on models and mathematical equations to "scientifically" construct predictions while disregarding the variability of the human response aspect.

According to F. A. Hayek, ``the unavoidable imperfection of man's knowledge and the consequent need for a process by which knowledge is constantly communicated and acquired. Any approach, such as that of much of mathematical economics with its simultaneous equations, which in effect starts from the assumption that people's knowledge corresponds with the objective facts of the situation, systematically leaves out what is our main task to explain."

4. Prediction dilemma.

The public tends to look for specific answers or forecasts from experts rather than examining the reasoning behind them.

For publicity seeking experts, an audacious gambit on forecasting could be a rewarding endeavor.

This, in my view, is where Mr. Roubini has capitalized from basking as a celebrity during last year's crisis.


The google trend chart shows of this phenomenon.

According to NYMAG, ``Since his forecasts proved correct, or semi-correct, Roubini's become an economic celebrity, practically a household name (okay, maybe only in the wonkiest of households, but still). He's been the subject of countless magazine profiles and is lauded by his peers. His independent economic research firm, RGE, has flourished, and he's always speaking at some conference, somewhere, around the globe. (And, with respect to Julia Ioffe, who wrote a great profile of the economist recently for The New Republic, we're not buying the idea that he's taking his message on the road out of some noble sense of duty. His fees must be astronomical at this point.) His stock has gone up with the ladies, too; as he recently told New York, "The recession has been great for me."

In my view, this represents as a personal victory for Mr. Roubini. He attained both the fame and the attendant fortune of booming business and adoring ladies. And maybe some of his critics could have been envious of this.

For us, this goes to show how doing our homework matters more than simply listening or heeding on the opinions of celebrity gurus.