Wednesday, January 7, 2009

Unprecedented Events Makes Prediction Impossible

I obviously follow the market and the economy quite closely.  The thing that you hear most often these days are comparisons to previous bear markets.  I cannot turn on CNBC and not hear someone state that, "this is the worse market since 1929" or that "We are in the midst of recovery because recessions typically last 15 months".  The thing I find most hilarious about these comparisons is that they are completely incapable of describing the current economic climate.

We as humans tend to have a need to compare.  People judge how well off they are by comparing themselves to their neighbor.  Hence the "keeping up with the Jonses" mentality.  People compare their own relationships to others to determine how how happy they are in their current relationship.  So it is no surprise that when it comes to economics, we wish to use the past to tell us what the future holds.  But just as in the stock market, you cannot determine future economic conditions by looking at past results.

To make it even worse, the data just is not there even if you want to make comparisons.  There have been about a dozen bear markets in the last hundred years.  That is simply not enough data points to make any sort of model.  If you add in bear markets during recessions and during credit crunches you whittle this number down to one or two other instances, and that is definitely not enough to give you any sort of statistical significance.  Of course people will say, "But, but it is only an extrapolation".  While true, any model has to have at least some similarities.  And seriously, we have not seen anything like this before.

The job numbers came out from ADP.  They used some funny math this time around, but it just confirmed what I already knew.  The job situation is getting worse, not better.  We have at least several more months of companies making cutbacks before we see any relief in sight.  The market took this news and dropped about 3% today.  I expect it to continue to go down and trade in a wide range.  850 on the S&P can come faster then you think.

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