Trader’s Narrative

In case you didn’t catch this, a curious exchange occurred way back on July 18th, 2008 on Google’s finance messageboard. It was not unlike the usual chatter that you are likely to read in this corner of the internet, full of mysterious innuendo, bold predictions and anonymity. But what made it stand out from the rest was that it came true:

That was enough to not only get people’s attention but garner the mysterious Nostradamus a cult following. The prediction was linked to a little known Catholic group called Legatus - a network of Catholic businessmen (and women) - think of them as the LinkedIn of the Holy See.

Then on January 28th, 2009 “reinhardt” emailed his next prediction:

February 09 2009

100% sure thing

market begins huge downfall

People waited with bated breath… and were disappointed because Monday’s market was a snooze-fest. Then came Tuesday and every screen was covered in red. Here’s a chart showing the timing of the two predictions:

What do you think? Has the stock market Nostradamus finally stepped into the light? or is this is just an elaborate (and ingenious) viral marketing campaign for Dan Brown’s next movie?

Personally, it reminds me of the massive “doomsday” option trade back in August 2007 (nervous giggle).

Groundhog Day is only a few days away! According to lore, if the groundhog sees its shadow, we’re going to have another 6 months of winter. If on the other hand, it fails to see its shadow, winter will end soon.

The January barometer can be likened to ground hog day but it has more historical evidence. The January barometer basically says that the performance in the first month of the year, predicts the market’s return for the rest of the year.

The S&P 500 Index (SPX) started January at 902.99 and ended the month at 825.88 for a return of -8.5%. The Dow fared worse with an 8.8% drop. For both indices it the worst January return on record.

So the groundhog has definitely seen its shadow and the bear market will continue.

The only faint silver lining is that the historical basis for a negative prediction is very flimsy. Probably due to the upward bias of the stock market over the very long term, the prediction quality of the January barometer is higher in bull markets. So this prediction of a continued bear market has only about a 40% chance of being accurate.

UPDATE:
Here’s an interesting related article by Nick Godt at MarketWatch

Speaking of a recession, here’s an interesting graph from Intrade, the prediction market for legal, political, economic events:

The chart shows the contract for a recession in the US economy in 2008. If there is a recession sometime this year, it will pay the holder $100. If there isn’t, it will pay $0. According to this, there is currently a 37% chance of a recession in 2008.

Interestingly enough, the chart seems to be the inverse of the stock market. Notice how in mid October 2007 it bottomed out just as the market was topping. And how earlier this year it topped at 75% while the market was trying to find its footing.

Two caveats though: one, this contract is fairly illiquid; two, while Intrade can be uncanny in predictions borne out of crowd knowledge, it isn’t perfect.

As an example, take the prediction from last year putting Hillary Clinton ahead of Barack Obama.

Intrade, is less of a pure “prediction” mechanism than a way to aggregate all available information in a process of price discovery.

Do you remember Didier Sornette? He is the visiting UCLA professor who became a bit of a celebrity within financial circles a few years back. Sornette co-authored a paper and then a book explaining Why Stock Markets Crash. He came up with a very sophisticated model which tried to not only explain the market but predict it years in advance.

Since at the time his model was bearish, Sornette quickly became the favourite interview subject of the perma-bears. He wasn’t right of course since the market went up instead of down.

Had he been right though, you can bet he would have become a sudden celebrity, sold millions of his dry academic book, been interviewed in Barron’s, launched a hedge fund, etc.

This is what he said in an interview on March 2003 just as the market was about to launch into a multi-year cyclical bull run:

…we predicted that the stock market will go up until the first to the second quarter of 2003 and will then start a long descend until around the end of the first semester of 2004.

And here is the graph illustrating this prediction:

At the beginning of 2006 the S&P 500 was at 1270 - approximately 500 points away from Sornette’s predicton.

Now, I’m not dredging this up in order to beat up on a well meaning professor of geophysics. My point is that listening to so-called ‘experts’ is financially hazardous to your financial health. And that includes anyone on TV, radio, or dare I say it? even a blog.

Be independant and seek understanding - from that money and success will follow. There are no shortcuts in trading or in life.

If you’re interested to learn more about experts and their predictions, listen to this lecture by Nassim Taleb: