Tuesday, 28 July 2009

They have no clue

The bar-headed goose is one of the world's highest flying birds. Every spring, they fly from their winter feeding grounds in the lowlands of India through the Himalayan range on their way to their nesting grounds in Tibet. Then, every fall, they retrace their route back to India. This long and perilous journey is not a safe one. They suffer predation from crows, foxes, ravens, sea eagles and others.

In order to survive, like any other animal, these birds build up a strategy to avoid being eaten by their predators. They observe their enemies' behaviour; the time they attack, the places they hide, their weaknesses and base their defence, rather instinctively, on these rational facts. It doesn't always work of course, but it often does.

Another obstacle these birds face while flying over the Himalayas is the weather. If the wind blows in the opposite direction or if heavy clouds are formed, the birds are forced to turn back path and try again later or risk dying. In this situation, the birds cannot build up a strategy in order to bypass the weather conditions because they are unexpected. The wind could blow in any direction at any time in these mountains and the geese can't really predict it. Sometimes, an unexpected change in the weather could kill them.

Geese cannot know how the weather would turn out and they are aware of it. It would then be entirely wrong to have one of the birds pretending to know the weather conditions in advance and lead the flock towards the unknown. It would also be completely unethical to have that bird looked at as if it were the star because it had it right a few times. It would be undeniably crazy to offer that bird a huge amount of free food because it pretends knowing the weather. So why do we believe, respect, look at and excessively pay the financial analysts and advisors?

Financial markets sure have some rational grounds; bad results of a company mean a bad performance on the stock market, a new CEO could mean a better management hence a good performance on the markets, etc. Nevertheless, 2007 and 2008 have showed some unexpected events that no one foresaw. A recent example is the series of unexpected events following the implosion of the subprime market (the implosion itself could have been predicted; actually Nouriel Roubini talked about it in 2006). News kept fuelling the markets everyday with surprises and everybody got lost. Some "gurus" like Jim Rogers or Marc Faber pretend to have all the solutions by saying that everything will collapse and that we should get out of the markets. Not very hard, because when the geese look out and find it windy, they don't need the famous goose to tell them to stay in.

Buy! Sell! Resistance or support levels are all very interesting indicators but everyone seems to be forgetting the most important factor: randomness. We are more often confronted to the inexplicable randomness of the markets than to its certainty. The analysts try to give us the most probable forecast based on the available information. So if it is the case, why do we have people advising us to sell a stock and at the same time others recommending us to buy it? Why do we have analysts, saying that the estimated price of gold in one year time will be 2000$ whereas another says it will be 600$? They have the same information but they interpreted it differently. They are probably going to have it right a few times during their career, does this make them reliable?

In life, one can be very pleasant and generous and nobody would find it useful to highlight this fact. However, when this same person does something bad, then human kind only remembers this one bad thing. In finance, it's the exact opposite. An advisor could have several bad ideas during his career and no one would comment, but when one investment turns very profitable, then this advisor is a genius and remembered as one. Finance seems to be the path to glory and no need to necessarily understand it perfectly. Rather odd, isn't it?

Generally, to be a successful analyst, one should understand its field flawlessly. Moreover, it is usually better if the field of work is an exact science. Biology, chemistry or geology are exact sciences. Even economics, which is a human invention, is rather correct - if I lower my prices, I should sell more (all other things equal). Finance is not exact; it's actually quite far from being exact. How can an analyst or an advisor work on such random grounds? Pretending to understand a science which is mostly based on chance takes a lot of courage and confidence, which could be admirable, or could also be a waste of time and money.

The financial markets are like the weather. Sometimes obvious - it's summer so the weather's going to be warm / Microsoft reported some great numbers, the stock is going to go up - but very often it is an unpredictable human-made labyrinth. When the analysts are right, they're geniuses. When they are wrong, they blame the markets for overreacting or for being irrational. They just have no clue.

1 comment: