Oversimplifying the Complex

One of the interesting aspects of the strategist’s job is the ever-present question: “Why is the market doing X today?” Brokers, clients, reporters, and traders all want an answer to this question that is 1) brief; 2) simple; 3) makes intuitive sense, and 4) helps to position portfolios or write an article.

Unfortunately, easy answers are often not very accurate ones. Oversimplifying “what and why” often distorts the complex factors impacting capital markets. When discussing their behavior, it is more accurate to discuss the many subtle and intricate inter-relationships between a variety of factors. These include investor sentiment, interest rates, valuations, money supply, mutual fund flows, growth, commodity prices, corporate profitability, momentum, technicals, tax rates and currency action. And to make matters even more complex, every one of these factors independently impacts almost all of the rest. It is as if the stock market is a fun house hall of mirrors.

No one, of course, wants to hear that answer. Such is the penchant for turning complex multi-variate systems into buzzwords. Single word answers like “Overbought! Earnings news! Momentum! Headline Risk!” seem to be the more satisfying, if less accurate, responses. These Pithy phrases have practically become de rigueur amongst commentators.

As this is a year divisible by four, the obsession with simple yet inaccurate answers is gathering momentum. Politics is the latest offender: The market is doing ____ (fill in the blank) because of “Dean/Kerry/Bush.”

The foolhardiness of this quasi-analysis should be obvious. And yet, it seems this useless chatter never ends. The risk to investors comes from acting on foolish interpretations of market activity vis-à-vis the political sphere. It is an expensive hobby for investors to base investment decisions on rationalized political perspectives of rallies and sell offs.

The market is a future discounting mechanism, not an oracle of the future. Some examples: The Iowa Electronic Markets failed to “predict” Howard Dean’s implosion or John Kerry’s rise. As some tried to blame the recent sell off on Kerry’s threat to the incumbent, these same pundits were noticeably silent on why Ralph Nader’s announcement a week ago failed to ignite a Pro-President Bush rally.

Regardless, it is far from proven that Presidents from either party are better or worse for the market. The reality is that no single factor is outcome determinative in the markets. That includes U.S. Presidents, also.

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