Buttonwood regresses

Buttonwood (in a now regular, weekly fisking feature on Ultimi Barbarorum) gets it mildly wrong again, 3 times in the same article! It is as ever his choice of sources which let him down. First he quotes Dresdner Bank’s perma bearish (and like all perma-bear-losers they can turn a pretty phrase) strategists who say analysts have problems forecasting the future. Thanks for that breaking news. Then he quotes a portfolio manager who says stocks move on newsflow in exaggerated increments and you can make money on the reaction, ie betting against the first move. Actually, in my experience, you can if only you sell real quick once you have made a small profit; one of technical analysis’ staples (I hate technical analysis by the way) is that on a big intraday move there tends to be a retrenchment ahead of an equally likely massive multi-day continuation in the next sessions. Another less well-known reason for big stock moves on small bits of info is the magic of compounding: a small hit to this year’s earnings actually compounds through base effects through each of the out-years in a Discounted Cash Flow (I love DCFs) model. Wiping 5% off 07 EPS can mean taking a hit on 10-20% off your terminal value. If you can remember your corporate finance classes you may understand what that means, especially for growth stocks. A bit abstruse, perhaps. But trust me, I am right.

Lastly, he seems amazed that historical beta is completely useless as a measure predicting stock returns: of course it is useless, it is a) historical (past performance is no guarantee of future returns) and b) is based the fallacious concepts of standard deviation and regression. The inescapable conclusion is that large parts of the capital asset pricing model may be wrong. This would be news, you would have thought, and could even have started a useful discussion; but your correspondent has other fish to fry.

Indeed, Buttonwood seems to think that the lack of impact subprime has had so far on the market is not because of the small sums involved nor the irrelevance of the issue in the face of larger forced such as huge liquidity, lower stock supply and rising earnings. No, it is because of “information overload”. Apparently Buttonwood thinks they were too distracted to do the right thing in the face of a subprime “crisis”. Investors should have freaked out, you see. Buttonwood and all his smart, bearish sources were fact right, and still will be, it is the market which doesn’t understand. It’s enough, ha ha, to almost make you think maybe it’s possible to make money in stocks! So Buttonwood perorates, bitterly, with the plaintive cry of the mystified ivnestment amateur who just got his butt kicked; it’s all too darned hard.

 All this confirms what most investors who lived through the dotcom bubble must feel: investors are not always rational and markets are not always efficient. But, judging by the subprime saga, spotting those irrational moments is no easier than it ever was.

Thanks.

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