“In the world of business, bad news often surfaces serially: you see a cockroach in your kitchen; as the days go by, you meet his relatives,” - Warren Buffet 2003 annual letter
"Wirecard and the Cockroach Theory" from my friend Alex Ineichen refreshes the thinking of Buffet on this topic. The idea that bad news evolves slowly but sequentially is important when looking at all markets.
The Cockroach Theory can be applied to macro markets as well as company cases. An outlier piece of bad news can be an indicator that other bad news is coming. Outliers can suggest a change in direction. Investors can be positive and just look the other way when they hear one piece of bad news. News could just be an outlier, or investors can assume it is a clue or a snapping of twig that gives us a warning of more bad news. Applying the Cockroach theory suggests that time series outliers should not ignored but respected as a clue for change.
The fundamental direction of any market does not just reveal itself all at once. There may be some clear exceptions with policy changes, but for the most part, any crisis or change in direction is revealed one piece at a time. For example, the increase in state COVID19 cases could just be an outlier, or it could be the beginning of a trend change. Investors have to open to an alternative model.
Perhaps this sequential thinking is the value of nowcasting and employing real time data. It allows for seeing and assessing new events quickly not based on a past distribution but on new evidence.
Most new data fall within expectations and most new information is noise. Most would like to believe that the status quo will be maintained. The Cockroach theory can be viewed as a Bayesian expression dealing with change in a time series market model. There is a prior distribution or belief, but new "bad" information or evidence can create a new belief. Investors have to accept the likelihood for change.
The fundamental direction of any market does not just reveal itself all at once. There may be some clear exceptions with policy changes, but for the most part, any crisis or change in direction is revealed one piece at a time. For example, the increase in state COVID19 cases could just be an outlier, or it could be the beginning of a trend change. Investors have to open to an alternative model.
Perhaps this sequential thinking is the value of nowcasting and employing real time data. It allows for seeing and assessing new events quickly not based on a past distribution but on new evidence.
Most new data fall within expectations and most new information is noise. Most would like to believe that the status quo will be maintained. The Cockroach theory can be viewed as a Bayesian expression dealing with change in a time series market model. There is a prior distribution or belief, but new "bad" information or evidence can create a new belief. Investors have to accept the likelihood for change.
No comments:
Post a Comment