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Lindley Estes is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Lindley Estes.

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Betting on patterns can lead investors into the rough

AN ENGAGING promo appeared on the cover of the Nov. 5 edition of Barron’s magazine.

The teaser promised an article inside on why golfing great Tiger Woods might not make a good CEO.

There’s no reason to think Woods would make a great CEO, as he’s spent most of his life on golf courses rather than boardrooms. Then again, Woods seems to have the smarts and work ethic that could lead to success as an executive.

It turns out the article was about the relationship between financial-industry CEOs’ golf scores and recent stock-market performance.

Companies led by solid golfers–including Merrill Lynch, Washington Mutual and Bear Stearns–have been stock-market laggards over the past few years. Meanwhile, financial companies headed by golf duffers or nonplayers–including Goldman Sachs and BlackRock–have done well.

Barron’s quotes a CEO with the following explanation: Golf takes a lot of time. So if a CEO is spending lots of time on the links, he or she may be neglecting boardroom duties.

“The evidence suggests that chief executives who spend too much time on the greens might not produce enough green for their shareholders,” Barron’s writes.

OK, it was an entertaining article. But surely readers wouldn’t pick a stock based on the golf handicap of the CEO, right?

Don’t be so sure. In his new book, “Your Money & Your Brain,” Jason Zweig writes about all the crazy ways humans look for patterns in the stock market that might boost investment returns.

He notes the following common beliefs: Stocks go up on Fridays, October is the worst month to own stocks, technical analysis can predict future prices and the market rises on years after a National Football Conference team wins the Super Bowl (not likely this year).

“Humans have a phenomenal ability to detect and interpret simple patterns,” Zweig writes. “Our incorrigible search for patterns leads us to assume that order exists where it often doesn’t.”

The search for order and meaning in historical stock-market data has at least two flaws.

First, there’s a staggering amount of available financial data. If you look closely enough at the numbers, some pattern is bound to jump out.

For instance, Zweig recounts the story of a money manager in 1997 studying which statistics would have best predicted market returns between 1981 and 1993. Turns out the best predictor was the total volume of butter produced each year in Bangladesh.

Nobody in his right mind would buy stocks based on such a silly indicator, right? Probably not, but some people do trust other patterns, such as that prices of small-company stocks tend to thrive in January.

That brings us to the second major flaw. If everybody believes these patterns, they’re not going to last. That is, if people think that stocks will soar in January, then prices will be bid up in December. That could lead January prices to lag.

As Zweig shows, evolution has provided us with brains that look for order amidst randomness. But the fact is, short-term stock returns aren’t predictable, regardless of what the talking head on television tells you. The only reliable indicator is how the underlying business fares over the long term.

Keep that in mind next time you consider dumping or buying a stock because of the CEO’s golf game.

Permalink: http://news.fredericksburg.com/businessbrowser/2007/11/11/betting-on-patterns-can-lead-investors-into-the-rough/