Market Indicators: The Best-Kept Secret to More Effective Trading and Investing

Chapter 6. Relative Value

	Though the stock market functions as a voting machine in the short run, it acts as a weighing machine in the long run.
	--—BENJAMIN GRAHAM

	The four most expensive words in the English language are, "This time it's different."
	--—SIR JOHN TEMPLETON

Many models attempt to characterize whether the current market is cheap or dear. They incorporate a variety of economic indicators, including aggregate money flows (such as M2), inflation (CPI), expected inflation, and the unemployment rate. They consider stock market measures such as price to earnings ratio (P/E), earnings momentum, or book value. Some look at currency rates, commodity prices, or even sun spot activity. The list goes on and on.

Today's cheap computer power, accessible historical data, and robust software packages offer nonprogrammers statistical modeling that was previously available only to the most sophisticated professional traders. But it's not easy to forecast the future. Investors often react in similar ways over time, but the patterns can shift in seemingly random ways, frustrating those who assume that the future will exactly mirror the past. The world's events are correlated in ways that are easy to see in retrospect, but nearly impossible to anticipate consistently.

It is still difficult, but much more likely, to come to an approximately accurate future prediction through a model of the past. Many investors have said that they would rather be approximately right than exactly wrong. The ...