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James Sogi: Unpredictable Ratios
The speculator's job is not only to provide capital to the world but to provide price information. The recently cited Goyal and Welch study found that none of the commonly touted financial performance or economic indicators have any predictive ability. This makes sense because we will never know or be able to predict the future. The financial and economic indicators appear to do a good job at explaining only the past and present. The speculator is the information processor who determines the current price and allocates the correct amount of capital using all the current information in what appears to be a trial and error manner. Though the future is not predictable, there are mechanisms at work which determine price action. As events unfold and change manifests itself, price must change, and the unfolding events include the price just set. As prices go up, more capital is allocated to a company or industry. That company can produce more of its product to meet the increasing demand. The increased supply will satisfy the demand thus lowering demand, lowering profits, and capital will be withdrawn. As commodities become scarce, the price will rise.
As the price rises, the demand drops, preventing scarcity. The mechanism for producing speculative profits may not be not predictors based on financial or macro economic ratios extrapolated into the future, but using those indicators applied to the present through statistical or other methods, the speculator can identify current price misallocations or error made by other market participants. The misallocation of capital is evidenced by trends or their extensions beyond reasonable a reasonable value and subsequent reversal. There appear to be plenty of opportunities to profit from other's mistakes Others have had plenty of opportunity to profit from mine. Looking at people one can see many mistakes they make in life, alcohol, drugs, anger, overweight, disrespect for their spouses and children. In the market, errors are evident in panics, bubbles, overly high financial ratios, excessive or overly low interest rates, excessive debt, misinterpretation of figures. All signify some sort of misallocation of capital and present the opportunity for profit.