Dec 5, 2007

Chris Leithner on the role of market strategists

My impression is that "strategists" are very skilled at summarising and expressing current conventional wisdom, i.e., knowing what presently excites the herd. That is, they don't influence mass expectations, and still less do they create them: instead, they reflect them.

Another impression is that strategists' "model" is, deep down and stripped of all its complexities, nothing other than a one-parameter regression. On average since the mid-'20s, the S&P 500 has increased, on average, by x% per year. From the early '80s to the late '90s, it rose by y% per year on average (where y > x). So, as a baseline, strategists will tell us that, during the next year, the S&P will rise by (say) (x+y)/2 percent. Clearly, these means have standard deviations, and so they pad their "predictions" with various fluff ("upside risks," "downside risks," etc.).

But during booms, the crowd expects -- nay, demands -- much better results, and during busts it anticipates worse ones; that is, the crowd tends to extrapolate the immediate past into the indefinite future. Strategists incorporate these expectations into their public utterances. So why do these folks not just keep their jobs, but prosper? Because their job isn't to predict the future: it's to tell people what they want to hear about the future. And why don't smartarses remind strategists of their past utterances? Because members of the general public don't, by and large, like to be reminded about past mistakes, and more generally that their expectations about the future and its actual course are very different things. Besides, directing the strategist back to his past vomit is, in effect, to question today's conventional wisdom (namely that the strategist knows something that the rest of us don't).

A final point: my impression is that strategists aren't remotely troubled by their past utterances because, psychologically, they're simply incapable of feeling sheepish. That psychological attribute tends to limit their supply, and the public's continuous demand for them ensures their price in the market remains high.

Chris Leithner, Leithner & Company Pty Ltd, December 5, 2007

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