A Flashback to the Future

Lately, when I read or listen to news sources, it's hard not to come across someone saying "Wall Street is dead as we know it", or words to that effect. A quick Google of the phrase "the end of wall street" yields over 48.5 million hits. Clearly, the concept is on a lot of people's minds.

I can't help but think back to last summer, when our collective attention was focused on one thing: gasoline prices. When a gallon of regular unleaded exceeded $4.00, there were many smart, well-paid, people predicting that $7.00/gallon gasoline was soon to be a reality, and a barrel of crude oil on the futures market would cost over $200.

Ostensibly wise, reasonable people made the assertion "the days of $2.00-a-gallon gasoline are over". It was so unthinkable that gasoline would be affordable again that this was a slam-dunk, no-brainer statement. You need only look at your local gas station to see proof of how something so clear and obvious at the time can quickly become irrelevant.

So I'm not sure why Wall Street was surprised when Geithner announced the details around the next phase of the TARP, and dumped mainly financial stocks to the tune of a 382-point drop today. Were they really expecting a man with less than a month on the job to definitively figure out the key to unlock the downward spiral in banking and the economy?

The triumph of hope over experience, indeed.

Few people truly understand how the world's financial markets work, and those who do understand its workings appreciate a small niche of it enough to make vast sums of money for themselves. And guess what? They're not telling anyone how it works, until maybe after the fact when they dish the tell-all story.

Why do I think this? Imagine if you could accurately predict where the traffic jams were going to be tomorrow morning before your morning commute (assuming, of course, you drive to work). If only you have this information, your prediction will most likely come true: you will be the only person on a back road and you'll breeze into work effortlessly.

However, imagine if many people had this information, not just you. Would that back road be empty? No. It would have many people on it as well; all the other people who had the same information as you, and who predicted that the back road would be clear.

That would invalidate the prediction, wouldn't it? So to stay accurate, your prediction would have to be able to adapt infinitely to take into account all the other predictions being made by your fellow commuters, who also have infinitely adapting predictive information. In the end, you'd be right back where you are now: unable to say with any certainty where the uncongested road would be.

And so it goes with trying to predict market behavior, and our immediate financial future: the more people who have a glimpse into the future, the more people will adapt to it, and therefore ruin the prediction.

Here's the lesson to take away from all this: the people who do get it are placing their bets now on what's going to happen, and they're not telling anyone about it. Anyone who publicly says they know what's next, doesn't know. Like the people who shorted real estate stocks just before the bubble burst, they will be happy to tell us about it after their party's over.