How NOT to Learn From History

Since the terms "recession" and "depression" first started making headlines in late 2007 (+/-) I've watched with horror as countless traders, analysts, flapping heads, journalists and other market participants blindly extrapolate historical patterns and apply them to our current situation. The most recent example I've seen (and my apologies as this is nowhere near the worst I've seen), is over at Clusterstock where Henry Blodget quotes Merrill strategist David Rosenberg (who, in fairness, actually includes some caveats):

It was extremely difficult for equity investors to make money in the decade following the June 1932 bottom. After the three-month rally (+75%) off the bottom in 1932, equity markets were extremely volatile and largely sideways for the next nine years. Keep in mind that the jury is still out as to whether the March 2009 lows were in fact the bottom, as was the case in 1932. 

Generally, we find such failed "analysis" takes the form of:

"In 19xx, the ____ Index dropped __ % over __ months, _________ economic indicators were _________, so judging from history, we conclude that now, we should expect X, Y and Z..."

Now, were conditions today exactly, or at least mostly the same as they were during previous recessions/depressions, I could see how this sort of analysis might make sense.  Contrary to the claims of others, I think its quite clear that global (and regional) dynamics and fundamentals are materially different than they have been at any earlier period of human history, which means these analyses constitute at least one type of logical fallacy, and are thus of little or dubious value.  No doubt, I'm guilty of some of these myself, but that's another story altogether.

I won't go so far as to claim that such claims are useless, since they may reveal some information about investor behavior and psychology, which is for the most part unchanged over at least the past few centuries.  However, this is hardly a redeeming quality of these poorly conceived - and even more-poorly used - forms of analysis.

No doubt both those who present and heed these arguments are suffering from at least one form of cognitive bias, although both are similarly blissfully ignorant of their own psychological predispositions and the like.

I'm of the belief that such forms of analysis - and those who propagate their use - do more harm than good insofar as almost any conclusion reached is, at best, a non sequitur, and may introduce or reinforce false beliefs to the investor population.  

Alas, despite the painfully obvious errors inherent in such comparisons, I still see them far-too frequently, in places and from people who should know better.

Tip of the hat to those who avoid such poor analysis, wag of the finger to those who don't!

Comments

[Kid Dynamite]

very well done... somehow though, my estimate is that 98% of forecasts are based on that flawed methodology... which is why they are a joke.

the other ridiculous point is the TINY number of data points they look at!

[Anal_yst]

@ KD

Its the "lets come up with analysis that reinforces our preconceived view of the world" approach.

Sadly, crap like that gets rewarded far too often, sigh...

[Kid Dynamite]

this is exactly why i feel good about the bear case now... because the bull case is basically "recessions last x months, and the stock market rallies y months before the end of the recession" - which i find embarrassing.

the main risk to the bear case is that the Fed just prints TRILLIONS of dollars and buys up all the bad debt, resulting in NOMINAL gains in the market, stupid americans feeling good and re-electing everyone who wants to get re-elected - higher inflation and higher taxation - which clearly results in everyone being POORER - but they can't tell because they are NOMINALLY richer... fahhhhhk

[Kid Dynamite]

barry's piece today is another super simple point wondering why we care what economists who have proven their INABILITY think...

http://www.ritholtz.com/blog/2009/05/yet-another-greenspan-housing-bottom-call/

[Anal_yst]

@KD

I feel great about the "bear case" although I loathe that term, but the problem is the guy on the other side of your trade has virtually unlimited resources, can change the rules at-will, and doesn't comprehend or care about second + order consequences of their actions.

[Kid Dynamite]

yeah, potentially true. i just read another summary of the bull case vs the bear case, which i think was accidental:

""bearish argument was more fundamental, while the bullish argument seemed to be statistical. "

exactly my point... and i'm a math guy too! i'll take the fundamentals though, over "average length of the previous 6 recessions"

[Anal_yst]

@ KD

HA, you knew it was only a matter of time before myself or someone else invoked Samuel Clemens' "Lies, Damn Lies, and Statistics..."