Investment Bias Against Contrarian Thinking : continued
Optimism Hides Structual Weakness
Common Blinders
Although every few years there is a financial crisis somewhere in the world, you might not witness a major turning point in your market more than two or three times in your working life.
Every few years there is a financial crisis somewhere in the world.
Although there is constant talk of market bubbles and busts, and short-term variations in business activity are common, a general institutional meltdown does not happen that often.
Every year there are books announcing a looming crisis or reckoning day.
Cassandras, contrarians, and doomsayers are a dime a dozen. After a while, like advertising, we learn to tune them out.
There is often not only a lack of consensus as to causes of past crises but also strong argumentation by market leaders and experts as to why the current market does not present special risks.
Don't expect that your conclusions will be ratified in the financial press:
- Ordinary investors, even professionals, have a tendency to make decisions based on what other are saying.
- Group think is a big thing in capital markets.
- There are many more people with access to a public microphone that have a financial interest in portraying the market as sound, than there are nay-sayers.
- Most market experts do not follow national flow of funds accounts and are unaware of techniques of Capital Flow Analysis.
Consequently, as a capital flow analyst you may be alone in your interpretation of the market.
For example, in 2004 it would have been clear to a capital flow analyst that the trade deficit was instrumental in driving long bond prices upwards and had been doing so for twenty years.
In 2004, most market pundits read the trade deficit the wrong way.
However, the trade deficit was almost universally decried as a negative factor that would drive bond prices downwards.
Nevertheless, the capital flow analyst would have been correct in predicting that an increase in the trade deficit would force long-bond prices upwards throughout 2004, while most market experts, including Federal Reserve Chairman Greenspan, were baffled or simply wrong.
Recognizing the lonely position of the capital flow analyst, the Capital Flows Forum offers a venue where analysts may exchange and check ideas with others familiar with this technique.
Summing Up
Capital Flow Analysis may make you aware of weaknesses in the financial system that others do not see.
Before jumping to conclusions and making dire predictions, make sure that:
- You have made a thorough Level One Analysis of the flow of funds accounts, with attention to historical trends;
- You have made an extensive Level Two Analysis of the motivation of major players that are driving the market;
- You have checked your ideas with other capital flow analysts, preferably using the Capital Flows Forum.
Do not expect your analysis to be readily accepted by others.
However, you should be willing to express your views in a professional setting, even if not immediately accepted.
The analyst that predicted that long-bond prices would rise in 2004, giving cogent reasons based on Capital Flow Analysis, might not have been listened to in 2004, but would probably have been afforded more respect in 2005.
Before proceeding, check your progress:
Self-Test
Predictions of economic collapse are:
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Many investors make decisions based on:
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Capital flow analysts should expect:
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learning module : continued >
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