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11/10/2005
Quiddities, by Victor Niederhoffer

Small Change

By some measures, the last four days in the stock market are among the least volatile in history. Four days in a row without a one-point change occurred just once in the last eight years. The market couldn't function with such small changes because the public would not be induced to lose so much more than they have any right to lose (as Robert Bacon would say) with such stasis. Apparently the predictive properties of similar runs of nothingness are not overly grandiloquent.

A New Meme

This brings up some recent doomsday forecasts. Reading through all the demography papers, I see that the mojo behind them all is that demography is why we're heading for Dow 500 real soon. Almost every agrarian is riding this dismal bandwagon, with the two chronic bears S. & S. from Yale and Wharton leading the hoped-for debacle race. The story is that the proportion of middle-aged in the population is going to decline, and this is bearish because in some models the middle-aged buy stocks whereas the seniors and juniors consume more they earn.

Comparisons and attributions to the Japanese slump and the comparable demographics in Japan and Europe are legion. And the only way to pay for such a shortfall in benefits and entitlements is to raise taxes. But this lowers the incentive to have kids because the after tax cost of having them is so much greater.

Such hoped-for abysmals looking at supply and demand as if they are static flows, without taking into account prices, incentives and the prospective rate of return on holding the existing stock of assets, are behind the grievous errors that flow-of-funds crypto-accountants make when predicting the decline of prosperity in one field or another. Recall the accountant Henry Kaufman with his perpetually bearish fixed income forecasts.

Health Tests

In medicine, the CEA count is a blood test that could save millions of lives annually if performed regularly. Since elevated levels of CEA are only 75% predictive of disease, rather than 100%, insurers won't pay for the test. Individuals won't assume the cost either, because they are induced by our system to lethargy and the belief that others are responsible for their health. Regrettably, this cost-benefit analysis fails to account for the money saved by catching a disease in the early stage.

The foregoing is a preamble to a market study. Are there any tests like the CEA for the market that would tell whether it's in a sick or healthy state? Looking at the plethora of indicators out there -- new highs vs. new lows, advance-decline lines, moving averages, Fibonacci charts, Hursts, parabolics, money flows, oscillators, envelopes and stochastics -- I want to turn myself in at the nearest police station as Willie Sutton did when the Dodgers lost, just to get some peace. Too many of these measures are highly correlated with the market's past movements and don't take account of the moves of other markets.

I propose the following as indicators of market health: the extent of prices slightly below the round vs. those slightly above; the number of other stock markets that are outperforming or underperforming; or some of the other things that the Minister of Non-Predictive Studies likes to look at.

Sayonara to a Bearish Scenario

It was just a month or two ago that the analysts and the media were lionizing the Sage for his bearish dollar scenario based on the twin deficits motif that if you are borrowing constantly then eventually the idiots who hold your unwanted currency through no volition of their own will have a revulsion that will cause asset prices to fall to zero or below. But now that the dollar is at a two-year high, 1 euro = $1.175, the strongest dollar since mid-2003, the Sage is not quite as so lionized. Perhaps his surrogate son will take a good  introductory economics course and learn that the current account deficit and long-term account balance are jointly determined by the incentives to hold balances and investments in the respective countries, their prospective growth rates and interest rates, and their comparative advantages in the provision of goods and services. And perhaps he'll be less willing next year in Davos to play "own man" in the game of "Your own man says it's bearish" to the immense cost of his stakeholders and reputation.

The two major reasons for stock market bearishness in the last few months have been the coming swoon of the dollar and the terrible impact of oil prices in the $65 a barrel-and-up range. Now that oil is in the $50s and the dollar in the teens, the chronic bears will have to turn their attention to something else, like demography.  The new meme doubtlessly will be the slowing growth of earnings forecasted for next year as compared to such ever-growing assets as the tree and the vine.

Dr. Kim Zussman Responds:

The analogy of a tumor marker to detect occult disease is similar to the use of any set of objective measurements of the body in diagnosis. The analogy is even better in veterinary medicine, where the patient can't tell you he is sick. Taking the temperature of entrants before a horse race might find a febrile animal to bet against.

Early medicine was limited to feeling the forehead or looking in the throat. But temperature alone is not sufficient to diagnose all relevant illness, and medicine progressed to auscultation, blood tests, imaging, and other findings in physical examination. Because of the variability of findings, variations of normal between individuals, and myriad old and new diseases, diagnosis is very difficult. A "good doctor" is one who gets the diagnosis right, as result of objectivity, study, and experience.

In markets most such diagnosis takes the form of post-mortem: Nazzy was sick in '00 but the full extent of the illness awaited the course of the disease. Even more difficult, once effective diagnostics and treatments are found the disease mutates, old treatments don't work, and more patients die than they have a rite to.

We need evolving diagnostics to determine which stocks are sick, and which are healthy, to plan for when inevitable stress visits. In addition to features of stocks, certain stocks and their behaviour under stress might provide clues about the whole herd.

Jim Sogi Responds:

Viruses have the ability to adapt, mutate and change into new ecological niches. Humans are adaptable, and change. Markets and their human participants seem to mutate, adapt, change and manifest in interesting new ways, sometime mutating from one state to another in the middle of one form. Structures or mechanisms branch off, or continue longer than was previously thought to be the norm. The idea of diagnosing the current conditions with some scientific methodology might be a good way to 'diagnose' the market condition and most importantly give a prognosis.

Brief research of the area shows some promising work in this area. Computational prognostic models are increasingly used in medicine to predict the natural course of disease. In recent years several methods and techniques from the fields of artificial intelligence, decision theory and statistics have been introduced into models of the medical management of patients.

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