Wednesday, March 14, 2007

The 10% Solution?

Bullish complacency has given way to …correction complacency! Specifically, the 10% variety.

The more I hear expert after expert recite the 10% correction mantra, the more I get the sense that a 10% correction is the last thing we will experience.

The problem I have is with the single point number: 10%.

Since when did a single point number like 10% take on such mythological certainty? It’s just a number, picked out of the air. And, as with key price points (1,000, 10,000, etc.), it has no value beyond the psychological. 10% says nothing about valuation. Nor, in fact, is it in keeping with the discipline of fundamental analysis*.

Perhaps it is the tidiness of a nice round number like 10% that appeals to so many. I could understand that. Nice, neat, tidy. Gives one a sense that all is under control. The world is predictable. Time to be complacent, again!

Unfortunately, the problem with this thinking is that investing is a social science. And, like that other social science called life, things have a way being messy. Sometimes very messy.

Investment Strategy Implications

If this year has taught us anything it’s that when the crowd believes in something so strongly, the odds are against it happening. In the case of the 10% solution: Nice and tidy meets the reality of human nature.

My impression is that that the market will get nowhere near 10%. That it will either stop right around current levels (200 day moving average, modest improvement in MACD). Or, the markets will drive well below that 10% number (second down wave), and, in the process, scare the bejesus out of everyone. Given the technical damage thus far plus unrepentant complacency (from bullish to correction), my bet is on the later.

*Note: This second point is particularly disturbing as making price point calls is the domain of technical analysis and outside the bounds of fundamental analysis – the discipline of the majority of analysts and strategists. Additionally, it has a market timing feel to it, something that numerous studies have made clear just doesn't work. Finally, it is made all the worse by being so precise on the magnitude of the correction - 10%.)

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