The more I learn about the market, the more I understand how truly random the daily movement has become. No, I am not just talking about how fear and negativity move the market on a dime; I am actually talking about how influential “voices” can move the market on just their words and they can do so without actually “knowing” anything.
A recent WSJ article points out that just about a year ago one of the more celebrated voices out there in the land of oracles predicted a collapse in the municipal bond market. Meredith Whitney did her tour telling everyone from CNBC and 60 Minutes that there could be as many 50-100 major municipal defaults resulting in losses in the hundreds of billions of dollars. I remember having a discussion with my brother about it, as he was in the camp that thought his state of New York would produce some of those defaults. He argued there was no way New York could find its way out of its fiscal problems. Fortunately, I convinced him to keep his portfolio intact, but there were many who heeded the words of Ms. Whitney, cashed in their bonds, and are now regretting their belief in her doomsday prediction. In the last year, not only did the municipal bond market not collapse, it actually performed quite well, relatively speaking.
Analysis that predicts a specific outcome with certainty is far different from analysis that projects possible outcomes. It is much smarter to track those who project possible outcomes. That way you can vigilantly watch and move accordingly. Blindly following the oracles leads to reactionary behavior, which, by definition, is not proactive or thoughtful behavior. Single voices can create reactionary and damaging behavior, as can a few voices throwing words around without knowing anything of real value as well.
While credit default swaps can help investors hedge risks and bet on market trends, the thin trading underlines a key shortcoming of an instrument that has a huge influence on risk perceptions. During periods of stress, the actions of a few traders can have an outsize impact on delicate market psychology. A Wall Street Journal analysis shows that actual trades in these widely cited derivatives are few and far between—and the quotes that market observers bandy about often aren’t based on actual trades at all.
The problem here is clear, but the above excerpt lacks one piece of important information that clarifies the problem and makes the problem far worse. The problem isn’t the few traders, as they are just doing their job. The problem has become the voices that now utilize the swaps market as a barometer of fear in the overall market. One would think that collectively those highly informed voices in positions of influence would look at the thinly traded swaps market and know that it is not a reliable gauge of market sentiment, yet, apparently, they don’t know that. If they do know it, then they are bad at their job, which is to objectively analyze data and then inform their audience as to what they actually know.
History is full of unknowing voices that shout about this or that, and when they do, believers react. In the market, ignore these voices. Be proactive, not reactive. Make your own choices …
Trade in the day – Invest in your life …
