Great Investors ask the Right Questions

by Jeff Miller

I am continuing my work on the Eight Traits of the Insightful Investor.

These are skills that regular readers of "A Dash" will already know as part of their routine. New readers can enjoy the show, and everyone is invited to join in the comments. Please let me know if you disagree with one of my examples or even if you have a different slant. I am also very interested suggestions for future posts.

Background

I have struggled a bit with getting this theme started. The basic reason is that I really want to be positive.

1. I embrace the openness of the Internet tradition. I encourage other writers, and we all learn from free exchange;
2. Information comes from many sources. I have cited cab drivers in the past. Eclectic is a motto for me; but
3. Credentials matter. The flow of information is a fire hose. The investor really does need to distinguish between those who know something and the pretenders.

The story so far….

My first installment got a nice reception. I showed that there was a missing time frame and a missing series. Some thoughtful commenters wondered how they might know that.

Good point!

There are some key questions that the insightful investor should always ask.

Take a look at a chart that has been prominently featured by two of the most widely-read and respected market sources:

In the description, John Mauldin writes as follows:

"Finally, let's look at two charts that my good friend John Hussman has posted in the past few weeks. John is arguing that stocks are now overvalued, overbought, and overbullish."

Mauldin's readers might easily get the idea that this was a "Eureka" moment – a new and exciting new discovery.

Key Questions

The first step is to avoid a knee-jerk reaction to the powerful message of the chart: Beware of another market top, just like the prior two!

Next, think carefully about the chart.

1. There are only two prior instances. This is not the basis for statistical inference or quantitative analysis. It is more like looking at two former case studies. How is the current situation similar to 2000 or 2008?
2. What characteristics define the three highlighted points? How are these distinguished from other times? How were these conditions identified?
3. What about the pre-1995 period? Were there any prior instances that might have been "false positives?"
4. Were the two former tops predicted in real time?

Doing Your Homework

With the questions in mind, it is possible to do your homework. Since Dr. Hussman has been publishing his views for a long time, it is easy to discover when the "overvalued, overbought, and overbullish" meme began. You can search for those terms and specify specific time periods. I went back year-by-year to find the first instances, leading to this result:

In my version, the red arrow shows when that theme first appeared. It has been a fixture of the Hussman commentary for over three years. If you saw the chart in this form, it would not carry the same persuasive power. Most people would conclude that the methods underlying the chart are in need of revision. That is beyond the scope of the current post, but it is a valid subject for future discussion.

Conclusion

As I emphasized in the introduction, I am not suggesting that either Mauldin or Hussman is intentionally misleading readers. It is easy to get locked into a viewpoint when you really need to step back and examine the fundamental assumptions. The lesson for readers – and we will see this repeatedly – is that even the leading sources provide evidence that deserves further scrutiny.

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