If You Can't Lose,You're a Loser
Lately, I have been hearing an interesting type of argument. It is a form of debate that is both disingenuous and dishonest. We will call this the “Can't Lose Argument,” or CLA. Worse than confirmation bias, it is a money-losing exercise in narcissism.
The CLA goes something like this: A data point will be mentioned, and no matter what the net change in that data -- up, down or neutral -- it is somehow bad for markets. Stocks, bonds, commodities, real estate, all are fair game for the CLA.
Let me share a few examples of it:
CLA: “This quarter, corporate earnings are going to be weak. Perhaps even a negative growth number. That proves a recession is close.”
The Rational Person, or RP for short, notes that analysts forecast higher profits.
CLA: “Well, maybe not negative, but soft -- worse than last year in the same quarter.”
Then earnings exceed forecasts.
CLA: “Yes, they are rising, but look at the ratio of corporate profits to gross domestic product. It is unsustainable.”
Let’s be polite and call this mental back-flip an evolution in thinking.
CLA: “Hyperinflation is coming or is already here!”
Our RP notes that the data have been showing little inflation and deflation has been the Federal Reserve’s bigger concern.
CLA: “The data is wrong, there is actually runaway inflation, according to shadowstats.com.”
But, our RP notes, Massachusetts Institute of Technology’s Billion Prices Project shows the government's inflation indexes are reasonably accurate and that inflation is moderate.
CLA: “We need to go back on the gold standard to stop destructive inflation!”
There really is no arguing with these folks.
CLA: “The market is wildly overvalued. This will end in a crash.”
To which our RP responds, Can we really have a bubble when so many people are calling for a crash? Is that likely?
CLA: “Look at Shiller’s cyclically adjusted price-earnings ratio -- it's wildly overvalued.”
But, as our RP observes, this ratio is going to rise for the next few years during the rebound from the earnings crash of 2008. Besides, the CAPE shows the market has been overvalued for most of the past 15 years. What about other measures of valuation that show markets are fairly valued?
CLA: “They are wrong. The Fed is inflating an asset bubble -- it’s the only thing driving stock prices.”
What, our RP says, about the recovery in earnings? They are up more than 150 percent since the lows.
CLA: “It's just because of the Fed's printing presses and share buybacks. Nothing else matters.”
How can one have a reasoned discussion with these folks? I wish they were familiar with Karl Popper. The philosopher and professor at the London School of Economics made the case thatscientific propositions or theories should be “falsifiable.” If a statement can't theoretically be disproved by experiments, facts or data, it is a false premise. It behooves all traders and investors to become familiar with this line of thinking.
The way to avoid falling victim to the CLA in markets is simple. Whatever investment thesis or specific position you hold should have some sort of line in the sand that allows you to state: “If this happens, my underlying expectation for this trade is wrong. This position is no longer valid according to the reasons I used when I purchased it. Therefore, I will unwind this holding.”
Lines in sand can be as simple as a priced-based stop loss or as complex as a proof that an investment theme has been disproved.
If you aren't occasionally wrong, then you aren't trying hard enough or taking enough calculated risks. Having a method to verify when you are in error is a sound bit of trading advice.
Beware those who are never wrong.
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Barry L Ritholtz at firstname.lastname@example.org
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