Dis and Dat - Hmmm Is That So? - January 2011
Hmmm is that so?
"I am not accustomed to saying anything with certainty after only one or two observations."
Andreas Vesalius
"It is deja vu all over again."
Yogi Berra
We find ourselves, once again, at that specific calendar change that makes most investments gurus decide that they will try to predict the future. In case you do not review previous year's predictions, we are under the impression that they cannot. We are certain that we cannot predict the future. Therefore, we throw in the towel on this competition. They win. Someone will invariably predict it right, and we will not, since we offer no prediction. One may rightfully ask, what else is there to do?
We believe a useful alternative is to consider how the scientific method can be useful in investment strategy. The scientific method is a process that involves the collection of data, the stating of a hypothesis, and the testing of this hypothesis to find the truth. Unfortunately, you never reach absolute certainty and you can only prove the hypothesis is false. In markets, we believe price is the current participants' hypothesis on the value of the position. We also believe that current consensus opinion can be wrong. Therefore, very similar to the scientific method we must gather data, make a hypothesis whether the current market price is far above, close to, or far below the true value. Also like the scientific method our hypothesis can be wrong. If we believe the current market price is far above true value, we may sell a current position. If it is close to our calculation of true value, we may do nothing, and if it is far below we may buy. We may also refrain from action, if we do not have enough information to make judgments on the current market hypothesis.
We believe that, just like the scientific community is constantly gathering new information, changing hypothesis and then retesting. Market participants do the same by gathering news and other information, constantly changing prices by buying or selling, and this is all in an attempt to discover where the true value exists.
So next time you hear one of those fancy predictions, we suggest you say… hmm, is that so? Then think about all the different ways it can be proven false.
See you next time.
James Pope
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