Reflections on a Bull

My bullish correspondent has been busy and gleefully siezed on my comment yesterday that:

There was good volume in the preferred share market today … and continued declines in the perpetual sector which, quite frankly, I am at a loss to understand.

rate, the steepening in the past three weeks is stupendous. This is really strange!

and says that he is interested in my comments on his view that:

this is due to  the Commercial paper/subprime scare ….

Well, for what it’s worth, Mr. Bull, I think you’re right. I think we are seeing the confluence of a lot of factors:

  • Retail is avoiding assets that they don’t understand – and retail, in general, doesn’t understand preferred shares very well.
  • Retail is avoiding volatile assets – and perpetuals have certainly been showing volatility in the past six months.
  • Retail is avoiding asset classes in which they have recently been burnt – there were a lot of new issues last spring, much of it probably sold to unsophisticated investors who watched the market prices tank before they’d even received their monthly statement
  • Retail is avoiding asset classes which have not performed well in recent memory – performance of preferreds in general and perpetuals in particular has not been stellar for the past year or so
  • Retail is attempting to time the market. They are waiting for the bottom, therefore they will wait until they’re sure that prices are going up, therefore, probably, they will miss most of any rally that happens.

But, Mr. Bull, I want you to pay particular attention to my caveat: For what it’s worth.

  • How can any of the above statements be proven? If I were to say that relatively high spreads recently were due to the Tri-Lateral Commission acting under the orders of the Illuminati, how would you prove me wrong?
  • What predictive value does any of those statements have? They explain everything, cannot be falsified, and predict nothing.

I think we can agree that spreads are relatively high. And given this view, I will agree that a rational investment allocation model – for instance, one that says that the proportion of preferreds in a portfolio will be within a certain range – should probably be on the over-allocation side while long corporate bonds should be on the under-allocation side.

But the world is chaotic. We can formulate a beautiful asset allocation strategy … and tomorrow little green men from Mars will arrive with the secret of unlimited safe energy, requiring only extract of squid’s brain to run, which will give rise to a bull market in seafood and bear markets almost everywhere else.

So I make a deliberate attempt to avoid calling the market. Not because I don’t think I’m smart enough, but because there are too many random factors, too many of Colin Powell’s Unknown Unknowns, to make such an exercise a useful expenditure of time. Instead, I concentrate on weighing small differences between the various preferred share issues … up, down, I don’t care what the market does, as long as I do a nickel better, I’m happy. I can compare apples to apples, and give you good advice as to which one will be better. I cannot compare apples to squid’s brains.

If anybody tells you differently … find out why. Chances are, they’ve got great explanations and poor results.

Update: As if by magic, Accrued Interest has posted on this theme today.

One Response to “Reflections on a Bull”

  1. […] Update, 2007-10-19: I should also link to two of my other posts on this general topic: One Bull Checks in and Reflections on a Bull […]

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