Historic price data is not a useful tool

By DAVID MOON, Moon Capital Management, LLC
September 6, 2009

Six months ago, Wall Street could have hardly looked more bleak. The Dow Jones Industrial Average had dropped from 13,000 to 6,500 in the previous ten months. The recession was continuing and deepening. Unemployment was climbing and each week the government was sinking a few billion dollars deeper into debt.

Being depressed seemed downright logical.

When depression leads to panic, however, people often make bad decisions. Many panicked investors sold their stocks in March when the Dow as about 6,500.

They missed the recovery to 9,500.

The people who didn’t panic and held onto their stock portfolios have been on a wild rollercoaster – one that hasn’t gotten back to the starting point. Their portfolios have probably recovered about to where they were in late 2008.

Although the folks who didn’t sell any stocks likely feel smarter than everyone else, that’s not necessarily so. In a period as short as six months, performance is as much a matter of luck as anything else.

The market could have just as easily declined another 45 percent from March to September.

The most obvious and painful lesson of the past couple of years is that some people were invested in stocks – or heavily invested in stocks – who shouldn’t have been. Investors who depend on their assets for all of their fixed income and can’t withstand significant and prolonged declines in the values of their portfolios shouldn’t own stocks.

Many of these vulnerable investors fell prey to the same investing sin committed by the largest of America’s financial companies. They ignored risk. They assumed that asset prices could only go up.

It didn’t happen for Wachovia, Merrill Lynch or AIG. And it didn’t happen for millions of small investors, either.

We’ve learned that too many people are content to base their vision of the future on the immediate past. How else could you explain the extreme difference in investor expectations between March and now?

In March, the almost universal expectation was that the near-term outlook for stock prices was negative.

Optimism is much more frequent today, based solely on six months of historic price changes.

There’s one problem with using an emotional barometer as a stock forecasting tool: a stock price doesn’t know where it’s been. Investors can spend tons of energy talking about 280-day moving averages or other statistical trend measures, but those tools are only historic measurements.

Unless you’re trying to impress someone or you’re writing an academic paper for credit toward your doctoral thesis in finance, that historic price data is mostly useless to a rational investment decision-making process.

Six months from now, the stock market will be higher. Or lower. Perhaps significantly so. The movement may be in reaction to changes in interest rates, the value of the dollar, a terrorist attack, the Chinese economy or some off-the-cuff Warren Buffett remark.

Or, over six months, the move could be completely random.

But it won’t be as a result of where the market has been in the past six months.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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