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$$ Davidson on Engle's "Systemic Risk Rankings"

Let’s just say he isn’t a fan…….

“Davidson” submits:

I had to laugh at Robert Engle’s new NYU Systemic Risk tool. His belief is that “…the market knows this stuff”.

It is unbelievable that the deep errors in Fama’s Efficient Market still can’t shake the myth that the market knows “all”. Most of the market is simply taking guidance from price movement to predict future prices. Engle is simply another example of people who think that they are so much more intelligent than average that they just as simply miss the market’s basics. They are trapped in their own myopic world.

There will always be room for value thinkers, at least for the next few generations. History is replete with the fact that most people accept what academics and their peers tell them. Humans operate thru the Limbic System (primitive emotional fight/flight response) when we do not have enough information on which to make a decision or if there is enough information and we can place it in the context of experience we think using the Lateral Prefrontal Cortex and Posterior Parietal Cortex(LP&PPC). Generally we trust the information garnered by known experts.

It is the extensive training that the military does that makes soldiers use the LP&PPC sections of the brain. It is why simple panic reactions to risk of sudden death are over come thru having been exposed to many similar situations in training.

LP&PPC thinking is what makes the difference between contrarian value investors and panic driven investors of the herd. When I have put the relatively simple market valuation and stock valuation tools together in a book, I will also spell out why the complex mathematical/computer models fail and why “Black Swans” should be expected as routine outcomes from the current reliance on mathematical analysis of psychological systems which is essentially what is the basis of the market.

Once the book is released probably as a pdf, I expect it to meet with some degree of skepticism by those who have never thought investing was that simple. The material will offer a completely different approach to teaching finance to CFA’s and MBA’s and PhD’s. It will be based on rates of return that are simply observed, be tied to ROE’s and tied to the levels of CEO management skills. You could call it humanistic but with a few numbers thrown in to help compare one good CEO to another. Sector analysis, alpha, beta, CAPM, sigma, the definition of “Risk = volatility over a period of time”, Black-Scholes and etc I will show have no basis for investing.

We have since 1867 thrown the mathematical approach and logic at the problem of divining an understanding of financial markets by looking solely at price movements. Mathematics as a tool to reveal knowledge has been used since Zeno of Elea (c.490–c.430 BC). It works for physics, but not for human systems. Yet, we have built a knowledge base since 1867 believing that if we applied enough mathematical analysis that the truth of markets would be revealed. Math is useless to predict the markets.

What does work is far simpler. Anyone can learn it who has 4th grade math! Anyone can learn to apply it! If we were all trained in looking from this point of view, no one would over-pay for stocks and no one would be a panic seller. The economy would not surge to levels that need such a correction that 8mil people are laid off. We would likely have a higher growth economy than we do now with much less pressure from inflation.

Of course if everyone was properly educated about reasonable market rates of return, then there would not be the market swings that provide the opportunities for value investors like you or I.

I meant this note to be shorter, but I was in a writing mood.

I’m think the BCS Rankings may be more accurate……