Beliefs and behaviors are what drive us all. Charlie Munger is probably one of the best practicing sociologists alive. Munger, the lesser known of the Warren Buffet and Charlie Munger duet has a passion for understanding cognitive biases and beliefs.
Many prognosticators etc. are asked to predict the market. Barrons newspaper drags out a few Gurus every year for their psychic dog and pony show. Inevitably the wrong question gets asked. Where do you think the market is going to be next year questions abound?
Ken Fisher does an interesting job of plotting gurus as a distribution and then placing bets on the holes in the distribution. His conclusion basically could be summed up as the blindness of crowds.
Here is a tool to pick where the market should be priced while removing the recency bias associated with thinking about todays index level.
As an anthropologist, I believe how questions are asked of others or oneself greatly determines the value of the answers.
1. As a percentage rate what do you believe will happen to corporate earnings next year?
2. What is your perception of a fair percentage return for equity risk over the risk free rate?
Using the tables below you can see where âyouâ predict the fair value of equity. The value of your prediction is most likely the equivalent of the price you have paid for it, i.e. don't try and buy a cup of coffee with it.
A crude match up of the Dow Jones Industrial Average could be seen here.
The Point of this exercise is to get rid of your own recency bias. In asking about fundamentals and value, you may find yourself coming up with a very different answer to a very popular question.
Here is a screenshot of the simple excel tool available for Download SPDJIAPEriskfreeyieldpredictionV1.0.xls .
Here are the stats from last year for the S&P 500 as of
- Earnings are down 25.3% YoY according to Barron's. $62.28 last week vs. $83.39 for the S&P 500.
- The current yield on the S&P 500 4.37% and 5 year T-notes yield 3.11%. This a current S&P 500 risk premium of 1.26%
- The historical risk premium for equities ranges from 2.5-4.3%
- Earnings can be seasonal (you may wish to use annualized data)
- Even a positive earnings yield might be destructive. The game is increasing your purchasing power long term, remember inflation erodes that.
Being able to pose the counter factual or re-frame a situation allows you to adjust beliefs and assess others behavior. This is a powerful life skill. Maybe it is even reflexive, have to ask George Soros about that. George if you are free for dinner, my wife is Hungarian and makes great gulyas.
*important notes, yes the risk free rate will change so your mileage will vary. Please submit changes and suggestions.