My topic is Themology. Some of you have read through, probably in particular, the works
of Mises, may have been exposed to that term in passing. Certainly, those of you who have
read Theory and History are familiar with the term Themology. In fact, I think there
There's two copies still downstairs.
So what is stymology?
Well, I'll eventually address that issue.
And how does it relate to fundamental analysis and fundamental analysis of what?
This talk specifically addresses security analysis, how we go through the process of
Selecting Stocks, Bonds, what have you, okay. So that's what we're going. And I've been teaching
finance and investment courses for about 14, 15 years now. I worked in the industry for five,
Merrill Lynch as a private money manager. And through it all, I thought it was interesting as
I went from practitioner to Ph.D. program, the divergence in views and the way the theory was derived and presented.
Quite honestly, I'm lucky I got my Ph.D. I just happened to find one guy in a department that shared some of my views and he sort of carried me through.
because I was just too antagonistic to a lot of my professors, you know, as I went through the classes,
okay, because, you know, here's the, you know, the ex-money manager, broker, whatever, you know,
with his comments about that doesn't work, this doesn't work, you know, what do you mean,
market efficiency, whatever. Okay, so those are some of the things. But as a professor these days
trying to address the subject to my students, you know, I said, how do I teach this stuff?
One thing that really matters to me, more than anything, is just really trying to get to the crux, to the truth, and giving a student something valuable, something they can take with them, something that works, not rehashing a book, models, theories, and things that I knew as a practitioner basically didn't work.
So this got me to thinking as time went on. I was very fortunate to, by luck if you will, maybe Providence, get a job at Grove City College and that's where I was introduced to the works of Mises and Rothbard and that's when the light bulb went on.
and this happened about 1999 actually. So let me start first by just sort of giving a little background on fundamental analysis.
Fundamental analysis basically looks at publicly available information,
You know, quarterly reports, annual reports of corporations, you look at suppliers, vendors, you look at the whole situation surrounding a firm, and you basically try to take that information and make sense of it, and translate that into some type of an estimate of stock price and appraisal, if you will.
Alright, I know the word valuation is used a lot, but you know, valuation sometimes means something different than appraisal, so you're trying to appraise the stock.
And fundamental analysis, you know, kind of got its big start with Benjamin Graham and David Dodd's security analysis published in 1934.
They of course are the, especially Benjamin Graham was the teacher of Warren Buffett.
So I know everybody here knows who Warren Buffett is, I believe.
In fact, as a note on Buffett, he did release his note to shareholders a few weeks ago on
February 28th, and that's a good read.
Everybody here should go to BerkshireHathaway.com and take a look at Buffett's latest assessment
of things.
It's very interesting.
But in any event, Buffett of course is one of the most successful, still in spite of the recent downturn, at least as of 2008, he was still ranked number two in the world in terms of riches folks live, so second to Bill Gates.
Alright, so he has a pretty good track record.
Once again, my topic is trying to look at Austrian economics and tie it together with
some form of security selection.
In particular, I'm honing in on fundamental analysis, and there's been other work done
here.
Passor presented a paper on market efficiency and the effects of entrepreneurship,
Shostak on fundamental analysis in business cycles, and also a short paper by
Casa on fundamental analysis as a form of arbitrage. You know, in spite of the
papers that have been written in the past, you know, nothing really forms a
This is a theoretical base for fundamental analysis.
So that was my quest, and it still is.
This is a work in process.
So this study strengthens the case for fundamental security analysis
as a form of security selection compatible with an Austrian economic view.
So that's where I'm going.
And we have to look at other methods.
So, I do a quick critique of competing methods
of security selection in terms of their consistency
with an Austrian view, okay?
Now you gotta watch because, you know,
I'm saying Austrian economics, but, you know,
to be quite frank, when I'm talking themology,
I'm not talking necessarily economics.
I'm talking about another branch of science
according to Mises, okay?
So, but we will use, you know, sort of a praxeological
approach to assessing the other forms, okay?
And it evaluates issues relative to fundamental analysis
as a primary means for security selection.
So, you know, if we look at it,
I'm gonna just take a fast look at it.
Technical analysis, okay, now technical analysis
basically means that those who look for patterns,
you know, look at charts and price volume,
use oscillators or use anything else
Technical Analysis, Quantitative Analysis, Passive Investing,
and of course fundamental analysis. Fundamental analysis boils down to stock picking. Picking
stocks for investing. Let's look at technical analysis first. Once again, what you're looking
We're looking for, as a technician, in many cases, some kind of a pattern, and as human beings, we all tend to look for patterns, so I think it's just a matter of the way our brains have evolved, so when you're out in the jungle, you can recognize what type of pattern of leaf is edible versus which ones will poison you or make you itchy
Which animal is food, which is which animal pattern, the tiger coming at you, eats you.
So we haven't necessarily had to use patterns to give us information about what we can anticipate
happening.
And we do basically the same thing with technical analysis.
So if you're looking for these patterns, they're going to help you foretell the future.
Okay, now one of my problems with this is that there's this presumption of causality, okay,
where these repeatable cause-effect relationships that the technician has to automatically incorporate, okay.
So when you're looking at, you know, some type of a head-and-shoulder pattern, something like that,
That dictates to you that although the market is going to go down from this point forward,
no real rhyme or reason for it, other than there's the pattern and something's going
to follow.
Of course, techniques like that, that really are sort of black box, bother me.
I have a lot of trouble with things where there's no theory behind it, there's no foundation
behind it.
Because when you're using techniques like that, that then you can easily, especially
in financial markets, succumb to the problem of randomness, you see.
Okay, because anybody who's invested in the stock market knows it's very difficult to
project which way things are going, and there's a lot of things that happen you just can't
anticipate or expect, there's just random things that happen, okay.
So, you know, one of the problems you have with head hole analysis, of course, is that
you may think you're doing something purposeful, okay, and you may be right just as a matter
of luck, okay.
You know, and I've read several books by technicians, you know, that, you know, Pring and others,
you know, will essentially tell you, well, you know, the stuff, you've got to be careful
and Cause-Effect, types of relationships like you do in chemical reactions and whatnot.
So human-based events are unique, non-replicative in our limited value and anticipated human
transactions.
To be quite frank, I still have, you know, looking for some input, because I know a lot
of Austrians tend to embrace technical analysis for some reason, you know?
So if somebody can shoot me emails or something and tell me why they think that I'm wrong,
I'd like to hear those alternative views, but I've thought about this time and time
again. I just can't justify it. Quantitatively, now, this is easy to knock out. This is real
easy to knock out. Now, what is it? Mathematical modeling and econometric applications to
identify investment opportunities. So you let your computer do the work for you once
as you've done the work of programming.
All right, now I'll just point to one author.
Okay, there's many studies on this.
This isn't something that I got to leave here, 2005.
This is a reference to his Fooled By Ram in this book, right?
Okay, but you can go back to financial texts decades ago
where you get this full-blown presentation
of how to develop the cap M as an estimate of cost of equity.
Okay, and then, you know, you always love this, you know, you get to the end as well, you know, there's major problems with this, though.
You have to spend a whole semester or something like that studying the thing and learning it, and you're all excited that, yeah, we can take this model and get something out of it, and then there's all these, you know, disclaimers at the end.
And you sit there and say, wow, you know, wait, I'm wasting my time on this.
Well, in any event, he was one of the first people really to come out and really articulate the problem with return distributions.
There's all kinds of ways that the folks in finance try to get around this.
Well, what about the central limit theorem?
And what about this?
This is another thing.
We can assume, it's okay, it's close enough and everything.
I know there's computer trading that goes on where you have non-human trigger points and stuff, but for the most part we've got human beings there.
Return distributions are not normally distributed. This being the core assumption of quantitative models.
So as I look at any one of those things, why do I say that?
So if I look at any one of those things, why do I say that? Because I know very few models out there that can use fractal geometry or they can use chaos theory or some other method that uses different types of distributions.
In fact, we don't know what the return generating process is for securities returns.
Now that's not new news.
This topic has been brought up repeatedly, or it's implied at least.
If you sit there and you read things by Mises, Hayek, Hassler, Shostak, Rothbard, they all
point to that same problem.
In spite of this, academics and practitioners are promoting ever more sophisticated financial
models and means to manage risks, generate returns and form mechanical solutions to financial
Problems. There's a little clip by Warren Buffett in his latest shareholder letter where he said that the Cayston librarians would be running corporations.
I would say maybe statisticians would be running corporations. You think about it. You just model it and put your data into it and grind out your output.
What do you need some of the exercise subjective judgment for for your expertise?
Passive investing, you know, current bad or emphasis investing, here we go, you know,
following the tech boom crash, right, you have folks that say, oh, well, you know, what
you need to do is just diversify globally, all right, you know, if you do that, you have
a good diversified asset allocation and you indeed, you know, look at your own risk tolerance
of Market Efficiency.
So this is your official market hypothesis, right?
EMH states that if market prices quickly
and accurately reflect known information,
the price is right.
The only unanticipated information can impact prices.
Yeah, as Austrians, we would say that the price is right,
but we might argue as to what the price is
and what goes into formation of the price
and what might happen in the future.
Okay, to the folks at maybe the University of Chicago,
where this kind of thinking originated,
this has more to do with information arrival,
the rational human being,
being able to anticipate information
and not anticipate some things
that just sort of come out of the air, both good and bad.
And because we can't guess all that stuff,
then the price just sort of follows
its own little stochastic process
or some random walker, Martin Geller,
whatever you want to call it.
All right, depending on your level of familiarity with stochastic calculus.
All right, well, you have to know that the passive investing is modern portfolio theory.
Okay, so your passive investors use the NPT.
Okay, it's, you know, real fast and loud, comes up empty.
But nevertheless, you know, what's this about?
Portfolio risk can be substantially reduced through diversification.
Don't put all your A's in one basket.
That sounds like sad advice.
But Harry Markowitz, back in the 1950s, 1952, tried to quantify this, all right?
And what Markowitz's prescription was, what NPT does is it says that you should invest
in securities or different asset classes based on a different view of risk and reward, based
on a view that you look at the cross-correlations between securities and once again you diversify
You can buy away some of the idiosyncratic risks, and you've got the risk there left over that you're paid to take, the systemic risk.
You use a quadratic program to find your security weights.
And if you want to, you can pick securities and throw them into the optimizer, as you will.
Most of these folks just sit there and take a couple of exchange-traded funds, indexes
or something like that and plug them into the optimizer and come up with their allocation.
There are a lot of problems with NPT.
Now, Passor, Austrian, in 89, basically states that NPT totally ignores the role of the entrepreneur
as one whose emergence disturbs the mix resulting in new opportunities for possible investments.
I translate that this way. The implication is if new opportunities arise that change
the risk-reward characteristics of the investment portfolio, then correlations between securities
are not stable and optimized portfolio will not achieve desired outcomes. So, you know,
some folks that use these things in practice and others that critique them are called error
Maximizers, okay, because you know what they do, they tend to, you tend to overweight in securities that are, for lack of a better description, overpriced, and underweight in those that may present good investment opportunities or be underpriced, okay, so lots of problems with MPT.
MBT has found its way into many aspects of the way our monies are managed these days.
You have your prudent investor rule that basically mandates now that you have to use a modern
portfolio theory to manage your assets, if you're fiduciary, if you're running a pension
Fund or something, and the Pension Protection Act of 2006 in relation to 401K plans, 403B
plans, states that you have two choices if you're advising on a 401K plan.
You either use an optimizer or you use someone who has a certified financial planning credential
This is the fiduciary to give advice and they can't take any commissions. They have to work on a fee base.
All right, but this NPT has gotten in there. It's very influential now.
Yeah, under NPT, a lot of folks will have to rebalance their portfolios, their mandate.
And sometimes the NPT will go hand in hand with some type of a strategic asset allocation.
And what you have right now is a problem where stocks have fallen down so much in relationship to bonds
that these guys are basically going to be forced to rebalance and buy stocks to bring the stock portion up
according to the stated objectives of the client.
And you see little rallies that seem like they come out of nowhere.
It could be an NPT rebalancing rally is what you're seeing.
Fundamental Analysis
1957, two copies downstairs, okay?
Similar to the method of study used by historians
and those involved in natural psychology.
Okay, now he goes through a lot of efforts,
you can read through theory and history,
I recommend it, it's a great book, okay?
And to sort of sit there and give you the difference
between someone who does psychiatry or, you know,
or does some kind of other kind of psychological study
versus the psychology we're talking about,
which is psychology of human emotions, motivations,
ideas, judgments, values.
Okay, so he doesn't use it.
This is clear to everyone, it's called thymology.
Okay, get the psychology stuff out of it.
All right, and my claim is that thymology
is basically the philosophy behind fundamental analysis.
Okay, knowledge of human valuations and volitions
is basically the crux of themology, all right?
You have volitions, you have free will to make choices,
basically a study of choice,
it's a study of why we choose one object over another,
the motives involved, the importance of security analysis
is used to understand why others may engage
in future courses of action.
All right, when it comes down to it,
any kind of entrepreneurial activity, okay,
whether it's security analysis or trying to pick stocks,
if you will, or trying to decide whether to put a grocery store at the end of the street,
is phenomenological, it's an act of introspection, you know, I'm human so I know to some extent
the way you may feel about something, right, you sit there and you sort of superimpose,
you know, the way others may act or whatever by sort of building a mental model in their
What you would do in a certain situation given a certain environmental stimuli or whatever, I don't know.
Okay, and a perceptible historical experience.
So it's what, to quote Mises, it's what everybody learns from interactions with his fellows.
It's what a man knows about the way in which people value different conditions,
about their wishes and desires and their plans to realize these wishes and desires.
So I'm always reading this stuff with, once again, a finance overlay.
How can I, how does it apply to my area?
How does it apply to my area when reading through these things and picking up these things by Mises?
So it begins with a study of historical data and events.
You study the past first.
You use what you learn there.
There you acquire your knowledge about the past, right?
More specifically, identify key factors that influence certain past events.
So as you're honing in, it's a learning experience. That's all it is.
Number three, current information, recent historical events, is interjected into the analysis
and then synthesized to form mental scenarios to evaluate future courses of action.
So this is a process that's putting it all together in your head.
It's a primary tool in the head. It's the primary tool of the entrepreneur, okay? So, you know, entrepreneur, every time you're doing something, you're going to do something new, right? You're going to look at something that no one else does, it's like, oh yeah, I know, franchise or something, but still, even at that, you know, you have to sit there and evaluate the situation at hand and you want to put your franchise there, right? Okay, so it's a primary tool in the engineer. It's a process that's based on the way we're wired, okay? Based on how the human mind processes complex information and the right conclusions about future actions.
This is what we're born with. We're not born with optimizers in our heads. We have this ability.
Fundamental analysis and those who follow it are basically engaged in a themological process.
This is where I got thinking about this because I watch my students. I have them do these security analysis projects.
Projects. What I started to see is by going through the process of doing a fundamental
analysis, they learned the industry, they learned how the economy affected that particular
company and its stock, and lo and behold, they're able to make projections that were
pretty good in terms of guessing which direction the stock was going to go in terms of its
is Increase or Decrease in Price, you never get the point estimates, the estimates of stock prices exactly right, but they could get the directions right, and they were pretty good at assessing whether a stock was over or under value, they were fairly right for that matter, okay, so, you know, and what do you do, right, so the initial task of fundamental security analysis began understanding the firm, its industry in a general economic and political environment in which it operates, one real, I think,
The advantage you have here is, if you're approaching your economic analysis from a proper perspective, an Austrian perspective, that that gives you a big leg up. You understand business cycles, right? Okay, you understand what generates them. Okay, so that's a fundamental advantage.
Assessment of historical data by studying economic conditions, the industry, corporate reports, news release, all that stuff that's out there, right?
Right? And you kind of put together into what you think is going to drive the value of that particular stock, if you will, at this point in time and in the near future.
All right? Once the investor is confident to the level of understanding, he then synthesizes this information into a coherent structure and uses the forecast and evaluates securities and investment merit.
He used the gedonkin, right? Okay, the mental experiment is what you use.
Alright, so you're playing through these scenarios in your head, going over, you're overlaying on what you think other people are doing through introspection, right?
And once again, you're just going over this head to head to head, boom, and out comes eventually a decision, a choice, okay?
So you form the scenarios in the future based upon various factors, the forces that are likely to influence earnings growth, whatever it is, levels of uncertainty or other events,
Professor, Douglas Block Performance, incorporates introspection to anticipate the probable assessments and actions of others, and progressing through the entire process, see the process, the time-logical process, fundamental analysis, the investor acquires what is needed to formulate an estimate and future performance. It's the time-logical process that culminates into the action of a buy, hold or sell. So this is a uniquely human process.
For lack of any better tool, we must take recourse to
thermology if we want to anticipate other people's future attitudes and actions.
Out of our general phenomenological experience acquired either directly from observing our
fellow men and transacting business with them or indirectly from reading and from hearsay
As well as out of our special expertise, experience, acquired previous contacts with the individuals
or groups concerned, we try to form an opinion about their future conduct.
It's easy to see in what the fundamental difference consists, at least for some, I guess, between
this kind of anticipation and that of an engineer designing the plan for the construction of
a bridge.
I'm a little leery about people being able to alleviate those two things these days, but nevertheless, I'll end it there.
So everybody has a chance to ask the other two panelists to pass themselves.