“Once something is used for hedging purposes, it becomes useless for predictive purposes.”

I know this is kind of a trivial insight now, but when I originally wrote it, it was more cutting-edge.� That said, it is still not fundamentally understood by most.� Most still look at a fragment of the puzzle.� Few look at the whole.

My poster-child for fragmentary thinking is this article: The end of stock market crashes? Do I disagree that correlations begin rising among risky assets toward the end of a bull market?� Not at all.� I have even written about it on occasion.

But if few understand this, then only a few will take shelter when correlations get high.� The rest will continue the disorderly party until the “market cops” show up in the bear market.

If it becomes a widespread idea, a market rule, etc., it may constrain behavior for some time, leading to no large crashes, but after a long while with no crashes some will assume that such crashes are not possible, and the rule is out-of-date.� Four� examples:

Stocks should yield more than Treasury bonds.

Stocks should yield more than 3%.

Q-ratio

CAPE10

Many items that have intermediate-term wisdom, and are known to have that wisdom, eventually get ignored.� The first two I listed were common market nostrums in their day.� The second seem to have more long-term validity, but get ignored by many who say, “It’s different this time!”

But even if everyone agrees that a certain risk measure is a correct risk measure, and it becomes a part of the market’s furniture, that doesn’t mean risk ceases.� It does mean risk takes a different form.� I think of all of the people decided not to take equity risk during 2000-2007, and decided to invest in residential real estate, or take risk through CDOs, subprime RMBS, etc.

Yes, they avoided risk in the stock market.� They ran into something far more fundamental.� The risk from all risky assets, public, private, leveraged, unleveraged, is everywhere, and it is very difficult to hide while taking risk.

The markets incorporate a lot of rules that have partial validity.� They are known variably, and apply variably.� At some points these rules seem sharp and prescient.� At other times they seem weak and outmoded.

This brings me back to my view that the market is an ecosystem where no strategy has permanent validity.� Strategies ebb and flow as many parties search for scarce returns.� There are well-known limits to markets, like the Q-ratio and CAPE10.� If the markets come up with another one, like risky asset correlations, it will have validity, restraining speculative behavior, until people overwhelm it, and a new bust happens.

The boom-bust cycle cannot be repealed.� But it takes many forms.

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