Published on 02-11-2025
Anyone who has followed financial markets seriously will know that market prices can sometimes deviate dramatically from “rational” valuations. From the tulipomania of the 17th century to the booms and busts of meme coins today, market prices can and have experienced wide swings that are difficult to justify based on their fundamental value.
The “irrationality” of the markets would seem to create opportunities for smart financial managers to try and time the market to take advantage of patterns or anomalies created by less-than-rational investors.
Managers should be wary though. Strategies that try to take advantage of historical patterns or anomalies in market prices are subject to the changing landscape of financial markets. The well-documented “momentum” anomaly experienced a dramatic reversal during the 2009 stock market rebound, leading to huge losses for many quant trading funds and the closure of Goldman Sachs’ Global Alpha fund. Index inclusion anomalies, once a rich feeding ground for hedge funds, no longer register as statistically significant for the S&P 500. We see this dubious track record continue today in the glut of artificial intelligence and machine learning strategies trained on mountains of historical data only to underperform the market.
How should managers confront the fickle nature of financial markets? A spectacular example of what not to do can be drawn from the 2023 failure of Silicon Valley Bank. SVB managed to accumulate an impressive deposit base by cultivating close relationships with venture capital funds and startups. Because interest rates had been low and stable for the past decade, SVB’s management thought they could make easy money by investing depositor funds into long-term bonds operating on the optimistic assumption that interest rates would remain low and stable. Bond markets decided they were wrong.
Rather than follow the sad example of SVB, prudent managers should take a cautious approach towards market valuations by hedging risks and building flexibility into their strategic planning. Don’t try to outsmart the market by extrapolating historical patterns in valuations and hoping for the best. Instead, focus on core business competencies and seek out investments that are likely to deliver long-term value under a range of outcomes regardless of the whims of the market.
Peter Giles Hansen is an assistant professor in the finance area at Purdue University’s Mitch Daniels School of Business. His research focuses on corporate finance theory, asset pricing, financial econometrics, and behavioral finance.
