How permanent are trends?

Wall Street's judgment has been influenced by past trends more than by any other single factor related to security values.

The avowed object of people in the market is to anticipate future developments, and the past is held to have no significance except as it aids in such anticipation.

Yet in practice it is almost the universal habit to base forecasts of future happenings on a projection of past trends.

This is notoriously true of both the professional's and the public's view of market prospects.

Nearly everyone is optimistic (or "bullish") because the market has been enjoying a spirited advance and pessimistic (or "bearish") after a decline.

In the same way, an industry or a company which has grown in the past is almost always expected to keep on progressing; those which have been on the downgrade are expected to get worse and worse.


Momentum

It is true that every established trend has a certain momentum, so that it is more likely to continue for at least a while longer than it is to reverse itself at the moment of observation.

But this is far from saying that any trend may be relied upon to continue long enough to create a profit for those who "get aboard."

Rather extensive studies which we have made of the subject lead us to conclude that reversals of trend in every part of the financial picture occur so frequently as to make reliance on a trend a particularly dangerous matter.  

There must be strong independent reasons for investing money on the expectation of a continuance of past tendencies, and the investor must beware lest his weighing of future probabilities be unduly influenced by the trend line of the past.

Can money be made on balance by following the trend of the general market?  This subject is too complicated and controversial to admit of our treating it her with out own selection of statistical evidence.

But it is appropriate to point out (a) that playing the trend is the standard formula of stock market trading by the general public and (b) that the general public loses money in the stock market.


Industrial groups

The public has a similar tendency to speculate in those industrial groups which have established the best market records in the recent past.  It is easy to show that this naive effort to exploit a historical trend is dangerous.

The trend of industry profits is no more reliable than that of industry prices.

Using earnings as a percentage of invested capital, between 1939 and 1947  we find that the average of the five best industries declined from 24.6% to 17.7%, whereas that of the five poorest advanced from 4.2% to 18.5%.

War conditions and their aftermath, of course, have played an important part in bringing about this extraordinary change in the relative position of prosperous and non-prosperous industries.

There are many unexpected reasons for the changed performance; the important thing is that performance trends do change and investment values with them.


Benjamin Graham
The Intelligent Investor