Reflective Coherence vs naive trend-following and conventional economic thinking

An author known as an evangelist for trend-following posted the following:-

Caught this ominous line: “Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory.”

in relation to the following link:-

Somebody (LT) commented in response that the charts of the homebuilders – the XHB ETF, and components LEN and TOL were at 3+ year highs, indicating that this was of more significant than the columnist opinion.

In response to this, and to my comment, the evangelist wrote that “rising home builder stocks is one issue and homeowners underwater is another issue. Two separate facts in their own right. Deal with both as they are…right?”

I thought this was fascinating, because it is a very clear illustration of the fragmentation and absence of coherence in the way moderns tend to think about financial markets.  I believe that the inference one draws from an isolated fact regarding inventory will depend very much on what other beliefs one holds regarding the housing market.  Facts have no meaning outside of a broader context.  So that the emotional tone ‘ominous’ is unlikely to be associated with one’s interpretation of this fact if one chooses to take into account the technical picture of the homebuilders.

What does inventory mean? To the extent that there is no new picture demographically, and people continue to occupy a similar sized space and are not moving back with family, it represents a desire for somebody else to bear/manage the price and depreciation risks of ownership. It takes time for entrepreneurs to set up organizations allowing institutional capital to invest in residential property, but it is certainly happening. See the report in Marc Faber’s Gloom Boom Doom report by the founder of Sabre Value fund.

The response was that for those who are trend-followers there are no inferences to be drawn – one ought just to trade the market for what it is and accept that any  trend can end tomorrow.

It is a very much representative of our age that people look at the fundamentals in a fragmented, partial way, not considering the significance of an isolated observation in the context of the overall picture, and lacking a drive for coherence in peoples’ beliefs across different domains.  For a modern one is long the market because one’s model is bullish, and one sees no contradiction in talking to others about how awful the fundamentals seem to be.  Talking about the fundamentals is just like sport, and has no greater significance than that.

One can contrast this to another, more classical, approach that insists on finding coherence in our beliefs across domains, related and unrelated.  If the technicals are bullish, and the fundamentals appear to be bearish then, bearing in mind the proven ability of the market to forecast fundamentals, it seems likely that one is overlooking a nascent improvement in fundamentals that is as yet below the perceptual threshold for more traditional participants and commentators.

A participant who understands enough that he realizes markets have a tendency to trend, but not so much that he takes into account the tendency of markets to forecast future fundamentals is throwing away possibilities for learning.

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One Response to Reflective Coherence vs naive trend-following and conventional economic thinking

  1. Here's my latest post on economics, "Labor Reallocation in a Depressed Economy".

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