I believe that behaviour is economics. The path taken and its choice points usually say more than the destination. Although 10 years of flat equity markets make Treasuries seem sensible in retrospect, few allocation committees would have had the behavioral discipline (stones) to miss the equity party in the late 90's.
Here are 2 charts showing the yield curves for govt debt and AA Sr. CDS from today and 2 years ago. The gap in Sr. Corporates is amazing, but what's 2-3 orders of magnitude risk change between friends.
People reviewing historical graphs always assume a fixed frame of mind exists along the X axis when in reality allocations and perceptions change along that curve. Having a disciplined process in place for the long term is key.
Most models would not have seen the corporate curve shift like this, as the credit crisis started in the real estate finance related sector.
Garbage in garbage out is rarely the problem with quant models. It is usually a failure in context, ie. the context of large events so broad that no particular model can effectively encompass them into the inputs. Swans show up in the blind spots by definition.
A good allocator watches many sectors. My own belief is that any sector variance, seen as positive or negative is important. Extreme positive variance is probably more important to watch than any other. Our innate bias when seeing positive variance is too cheer lead instead of getting nervous, this behaviour is anti-thetical to good risk management.
Hence my apparently elliptical reference to muni-credits lack of response to the Geithner plan yesterday. The argument appears a non-sequitor, linking an equity rally with a flat muni-risk response. I view it is a lack of confirmation in expected economic growth delivering taxable revenues at the state level.
The woods are all around us, we aren't out yet, so stop looking at the equity market trees, this is a credit problem becoming a serious consumer demand problem.
