Tick or trend?
It’s not the latest Halloween ritual (sorry, couldn’t resist), but rather the basic choice every investor, corporate executive, analyst must make in forecasting what’s most likely to come next.
If you had been paying attention in March, you could have made 48.2% since then on your investment in the DJIA index. If you did, congratulations—but don’t spend the money just yet.
With some of the world’s major stock markets up by over 50% in six months, it’s clear some kind of serious rally is under way. But is it a trend—a genuine rally that signals a bottom, and an end to this long recession? Or is it just a tick—a “sucker’s rally” that gives everyone false hopes before plunging us to even greater depths?
So far, in some respects the stock market is behaving like it did during 1929-30. In the figure below, you see where we are now compared to where “we” were in 1930. (The numbers are accurate, however the timelines are not drawn to scale.) Then, as now, we lost about 50%, then in short order gained about 50%. (Note to poets: This does NOT put us back to where we were, but rather at 75% of that.)
Now some are forecasting that the next bull market is already under way, and that DJIA will double from here, putting it well over 25,000. That the recovery, in other words, will be V-shaped, as shown by the dotted gray line.
The second figure shows what actually happened in 1930. After recovering by nearly 50% (as it did this year), the DJIA underwent false rallies five more times during the course of a two-year slide that left it at a little more than 10% of its peak value. It was not until the mid-1950s—a quarter century after the original crash—that it again reached its 1929 peak.
So let’s play “tick or trend?” Is this recovery going to be V-shaped, W-shaped, or inconveniently shaped like something other than a letter from our alphabet? Even more importantly, how—and when—will you know the difference?
This same decision process applies to any business decision made under uncertainty—which includes virtually all the consequential ones.
Any good forecaster knows that after you run your models, you typically make (at least) three forecasts—an upside scenario, a downside scenario, and a most likely scenario. This way you’re covered with a range of options, including the one you deem most probable.
What some of us forget—or ignore, for any number of reasons—is that during the post facto period—the period that represents the “reality” for the period for which you’ve previously made your forecast—you can (and should) monitor the actual results to see which of your scenarios is actually developing as the closest to the truth. And if none are matching “what is”, you need to go back and adjust your forecast.
In effect, you need to tune your forecast as the future becomes the present. This sounds less sexy than “predicting the future”. But no one can accurately predict the future—since, as that great philosopher of life Ringo Starr put it, “Tomorrow never knows.”
So what should we do? Throw up our hands, unplug our models, and join the philosophizing about how random the universe is? Maybe in some respects it is—but that doesn’t help anyone much.
What we can do—and what those who profit during uncertainty make a practice of doing—is what I’ll call predicting the present. That is, they develop a deep understanding of what happened five minutes ago, and what happened earlier today, and what happened yesterday, as far as its impact on tomorrow and beyond. They don’t just do this once, once a year, or once a quarter. They cultivate and hone an ability to do it continually—in real time, and while everything else is going on. It’s not so easy, especially at first—but the rewards for being able to do so are extremely rich.
I’m reminded of when my finance professor, the late Ron Wippern of the Yale School of Management, used to speak of “cyclical versus secular” trends. Is a trend cyclical—that is, part of what we have become accustomed to think of as the “business cycle”, and worthy of (at most) a tactical response that matches its cyclical nature? Or is it secular—a long-term trend worth investing in for the long-term?
During periods of great instability and rapid change, it’s more important than ever to know where things are headed. This means being able to “predict the present”—to see clearly and deeply what is happening NOW, and what it implies for the FUTURE.
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on A brief pause: “Excellent advice thank you for your terrific reflection piece Tim!” Jan 15, 09:40
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“Predicting the Present” seems like such a simple concept, but, as you pointed out, probably rarely used as a managing tool because it’s not sexy.
You’re a genius!
Great article Tim.
Predicting the furture is near impossible; predicting the present is really hard; and most surprisingly, predicting the past is getting much harder too.
On this Columbus Day (need I say more?) what was the biggest cause of the economic meltdown? I have my strong opinions about that, but the past will be defined mostly by the authors of tomorrow.
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If only more companies did as you suggest and make it an ongoing practice to “predict the present” — and use The Knowledge Agency’s services — they’d clearly be able to be more competitive. But so few do…
An interesting article about the problems of predicting the future, particularly using the past to do it. In your article, using the history of the Crash of ’29 to determine what the stock market will do in the future is a perfect case in point. But thankfully we DO seem to learn things from past mistakes. In this case, during the Crash of ’29 the Fed was prohibited by law from intervening and increasing liquidity. As we know this time there was no restriction hence the injection of TARP funds to prevent total financial meltdown of the markets. So the beginning of prediction is to understand the underlying economic and financial architecture that is at the heart of our liquidity system that feeds into the credit markets, banking business, and stock markets. Using “norms” during times of “panic” doesn’t help the work of prediction biz either. The DJIA dropped to 6,500 quickly because we all panicked with the implosion of the global derivative markets (the sub-prime aspect was merely the trigger but not the bullet) – and rightly so given the scope of the problem. Naturally, if you think the world is ending you sell whatever you can for whatever you can. Consequently, “normal” valuations were meaningless and the market was oversold. It has since “rebounded” now that we know that we’re not going off the economic cliff. In the interim there appears to be some $6 trillion on the sidelines that WERE taken out of the markets waiting for a firm indication of economic direction. Hence the return to 9-10,000 on the DJIA. Much of this is long-term positioning given the extend to the overselling that took place. Finally, there IS that “stimulus” bill. Although only 20% of it has actually entered the economy in 2009, there is some $600 billion still waiting to enter early in 2010. This is equal to roughly 4.3% of our GDP, so it is not insignificant – equal roughly to 15 months of normal economic activity. The issue, then is whether this injection will unlock the cash waiting on the sidelines to return people to “normal” economic activity. I suspect it will “relax” the markets somewhat as people pay close attention to consumer spending (since 70% of our economy is based on consumption) and unemployment (since more people employed ipso facto increases spending). Unfortunately not much of that $600 billion seems destined for private sector stimulation so we’ll have to wait to see whether it is sustaining. So the “recovery” IS underway to the extent that we’re not going over a cliff. It will, therefore, be more like a “U” recovery. Of course, part of most economic predictions are trapped into your tri-partite approach in terms of high/low/expected based on present-value “norms”. The problem with this is most economist don’t then say: “So what could possibly go wrong that can screw up ALL of our assumptions?” That, after all, is how we got into this mess. Unfortunately there are quite a few of these, not least: A crash on the dollar, increased trade deficits, oil prices spiking, and the economic impacts of the “stimulus” bill, health care “reform”, new tax rises (that have to come), a less robust return to consumerism, and the next “reform” issue that must be faced – social security. Unfortunately ALL of these issues are quite possible. So in properly predicting the future, it isn’t “cyclical” so much as “cynical” that makes the biggest difference.