Is Financial History Bunk?

Henry Ford said it first and best, “History is more or less bunk”. Is financial history any different? I ask myself that question a lot lately, almost every time I read something where the analysis compares the current “recession” to the average of something  in a prior recessionary period.

For starters, there are precious few prior periods, with less than a dozen downturns worth the name in the last century. So we’re already working from a tiny sample size.

Second, there are oodles of reasons to expect that such situations are closer to unique than analogous. Is the previous example a recession? A depression? Was it in the U.S.? Where were rates going into it? Was it consumer led? What was inflation at the outset? Where was unemployment? What triggered the downturn? What was consumer debt load? I could go on and on, but you get the point I’m sure: History is awfully flawed as a guide for what is going to happen next when you’re dealing with small sample sizes and when inter-period situational variance is so high.

So, why do it? Why talk about which sectors lead in/out? Why mention that this is the best two-day week in modern market history? Why talk about the length of typical recession since WWII? Why go to any of those lengths? In part because it makes people feel better, which is nice; in part because it gives market analysis the patina of a science, which is wrong but also nice. And, yes, there is also that sometimes there is even some validity to it — that, all else being equal (which it rarely is), we might things to unspool in a similar way this time as they did the last time something like this happened.

The risks of financial history are higher than ever though. We have more data, better analytical tools, and more people crunching the data, so we can expect to see data on pretty much anything we want to see. There will always be someone tearing apart something to find something interesting, so something interesting will be found. My friend James Altucher has always been great on this subject, ripping holes in pretty much every data-driven rule of thumb by which people claim to trade and/or find market tops and bottoms. They mostly don’t work.

Anyway, I’m torn on the subject, but I’m also increasing skeptical of any and all comparisons to prior historical periods. I don’t buy trough P/E, or recession length, or relative valuation, or interest rate, or sectoral rotation arguments, or… you get the picture. I love data, but I’m increasingly close to being an outright nihilist when it comes to over-reliance on historical financial data without any truly coherent supporting rationale. We are in a grand experiment with no real history to draw on, and anyone who pretends otherwise is deluded or selling something, or both.

Thoughts?


Originally published at Paul Kedrosky’s blog and reproduced here with the author’s permission.

One Response to "Is Financial History Bunk?"

  1. Sigmund   January 9, 2009 at 6:44 am

    Very Good!! If you’re looking at history for guidance in the current situation, you’re looking at the wrong clock. Lets join and try and see thru the fog, the question is: What lies ahead. What I see is the potential for hyperinflation. How do we avoid that little beauty?