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Ep. 369: Market Predictability with Michael Covel on Trend Following Radio

Market Predictability with Michael Covel on Trend Following Radio
Market Predictability with Michael Covel on Trend Following Radio

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Just as shamans have been consulted throughout time to provide the desperate and gullible with prophecies, so too are financial shamans (often masquerading as experts) are looked to for comforting myths about market direction.

Of course, we can and should prepare for the many possible market eventualities by looking at the data and trading trends, but to expect anyone to be able to provide absolute predictions for the future is absurd. The truth is that we do not know for sure, and anyone that tells you they do know might as well be gazing into a crystal ball.

Today’s episode looks at the various attitudes and beliefs concerning the falsehood of market predictability. Michael Covel runs the commentary, drawing a narrative thread through various excerpts from some of the most prominent economic and financial thinkers.

In this episode of Trend Following Radio:

  • Recognizing when you are being misled by the experts
  • What to look for in trend analysis and what to be wary of
  • Considering bubbles and other unpredictable global factors in the markets
  • Finding an objective approach to investing based on quantifiable information
  • Considering timeless human investment psychology elements
  • Making investment decisions without being blinded by rigid economic processes or political ideologies

“It’s mind numbing to study financial history, because it is so repetitive: we do the exact same things over and over. We have followed this pattern in every major bubble, starting with the coin mania in the Roman empire.” – John Galbraith

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Greenspan Wakes Up to Behavior

From The Wall Street Journal:

“I’ve always considered myself more of a mathematician than a psychologist,” says Mr. Greenspan. But after the Fed’s model failed to predict the financial crisis, he realized that there is more to forecasting than numbers. “It all fell apart, in the sense that not a single major forecaster of note or institution caught it,” he says. “The Federal Reserve has got the most elaborate econometric model, which incorporates all the newfangled models of how the world works—and it missed it completely.” He says JP Morgan had put out a forecast three days before the crisis saying the economy was on the rise. And as late as 2007, the International Monetary Fund also said that global risk was declining. “A few days [after the crisis hit], I run into an article, and it is titled, ‘Do we economists know anything?’ ” he says.

Mr. Greenspan set out to find his blind spot step by step. First he drew the conclusion that the nonfinancial sector of the economy had been healthy. The problem lay in finance, because of its vulnerability to spells of euphoria and irrational fear. Studying the results of herd behavior provided him with some surprises. “I was actually flabbergasted,” he says. “It upended my view of how the world works.”

He concluded that fear has at least three times the effect of euphoria in producing market gyrations. “I wouldn’t have dared write anything like that before,” he says.

Studying the minutiae of the events leading to the financial crisis brought to mind some lessons from his famous friendship, from the 1950s on, with the late Objectivist philosopher Ayn Rand. He says that Rand didn’t influence him politically—he was always a libertarian—but she did point out tensions in his philosophy about life. “She caught me in contradictions, which shook me, and I said, ‘My God, she is right,’ ” he says.

Mr. Greenspan then believed in analysis based mainly on hard science and empirical facts. Rand told him that unless he considered human nature and its irrational side, he would “miss a very large part of how human beings behaved.” At the time they weren’t discussing economics, but today he realizes the full impact of emotions and instincts on markets. He also has come to admire psychologist and Princeton University professor emeritus Daniel Kahneman’s work applying psychological insights to economic theory, for which he won a Nobel Prize in 2002.

Good for Greenspan. So late to the party.

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