RealMoney

The latest Street.com column is up: “Myths of the 2004 Election.”

Its a look at some of the more annoying fallacies of this elction cycle.

Variant Perception

“Variant perception” is an investing stratagem used to obtain a philosophical advantage in the market. The key to this is in determining what other investors might be either overlooking or taking for granted. If you can find out what’s wrong in everybody else’s assumptions, then you will have a distinct advantage.

Previously, we looked at several variant perceptions: Our review of so-called presidential futures showed how unreliable they were, despite their heavy usage by high-profile journalists. Further, our discussion on how many had confused politics with economics took a similar tack. We even looked at the correlation between the S&P 500 performance and the president’s approval rating, and saw how some analysts drew exactly the wrong conclusion from the charts.

Let’s apply this variant perception to the more common myths bouncing around the mainstream media today — the illusions that might negatively affect your investing.

The market hates uncertainty — it astounds me how these words so totally misunderstand capital markets, investor psychology and the basic principles of physics.

Investing in the stock market is about the future. By definition, the future is uncertain. Hence, the markets are all about uncertainty. Put another way, when you invest in a company, you are essentially making a prediction of what a dollar of that company’s earnings is worth X months in the future. Oh, the uncertainty of it all!

Consider what would happen if there weren’t uncertainty. Who would take the other side of your trade? If you are a buyer (seller), without uncertainty there would be no sellers (buyers).

Consider the opposite: When has the market been certain? I recall in March 2000, when the Nasdaq was over 5,000, everyone seemed certain we were going to go much higher. (I assume you recall how that worked out.) In October 2002, a lot of profitable tech and telecom firms were trading for less than book value — and some were trading for less than cash in hand — the market was certain we were going much lower. In other words, investors had collectively decided that $1 was worth about 75 cents.

So much for certainty.

Like most cliches, “The market hates uncertainty” started out with a grain of truth. Then it got dumbed down so as to lose all value.

Instead of saying “The market hates uncertainty,” what we should say is, “Investing when externalities are extremely difficult to discount is unusually challenging; in those instances, the market’s future discounting mechanism provides no insight into the likelihood of any one particular outcome over another.”

That’s a very different statement from the silly sound bite: “The market hates uncertainty.”

Category: Economy, Finance, Politics

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