Monday, May 25, 2009


Isn’t history bunk?
  • “Progress is cumulative in science and engineering but cyclical in finance” -James Grant (Money of the Mind)
  • “. . . for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty” Royal Swedish Academyof Sciences announcing Daniel Kahneman as recipient of 2002 Nobel Prize for Economic Sciences.
  • What is financial history if it is not a study of ‘human judgement and decision-making under uncertainty’?
So, what practical use is there in history?
  • History looks at how markets have worked and not how they should work
  • Furthers our understanding of how human decision making under uncertainty works in practice
  • To discover some of the lost secrets of our investing ancestors — the pre-Markowitz (1952) wisdom
  • To recognise a bear, spend time in its company

Defining g the bottom of a bear market
  • When were the best subsequent returns achieved?
  • Calculate hindsight value
  • August 1921, July 1932, June 1949, and August 1982
  • December 1974 would have been the fifth great bottom

  • Value considerations are not enough to find the bottom — Q ratiorelative to geometric mean — equities get cheap and keep getting cheaper
  • Analyse the turning points in these bear markets with the benefit of hindsight
  • Analyse the turning points based on contemporary opinion right and wrong
  • 70,000 WSJ articles — good sample of contemporary opinion
The bear ends when deflation abates
  • Inventory in the system is low
  • Some commodity prices start to stabilise
  • Demand evident at lower price, particularly for luxury goods or goods in structural demand
  • Greater certainty on general price level and valuations more certain
  • Corporate bond rally?
Commodity prices bottom with equities
  • Commodity prices bottom Aug 1921 with equities
  • Commodity prices bottom July 1932 with equities
  • Commodity prices bottom July 1949 with equities
  • Commodity prices bottom Oct 1982 just after equities
  • Copper price bottoms August 1921, June 1932, June 1949 and June 1982
Bonds first, , then equities
  • August 1921: May 1920 government bonds, June 1921 Baa corporates, August 1921 commodities.
  • July 1932: January 1932 government bonds, May 1932 Baa corporates, July 1932 commodities
  • June 1949: October 1948 government bonds, January 1948 corporate bonds, July 1949 commodities
  • July 1982: October 1981 government bonds, February 1982 Baa corporates, October 1982 commodities