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November 26, 2008

Over-Rapid Change, Swimming, and Capital Markets

As most readers of this site will know, I'm a junkie for sports science. Combine that will capital markets and you have me cold. Some new analysis got me thinking today about the two -- sports and capital markets -- in the context of over-rapid changes in an existing "market", in this case competitive swimming.

As anyone who following the Beijing Olympics this summer (remember those?) will know, swimming records fell with abandon. Rather than drugs, however, the putative cause was new technology in the form of low-drag bodysuits. These expensive creations allowed athletes to trim great gobs of time off their own personal bests, turning into records across a host of different swimming distances.

Consider the following table from the above analysis. The green arrows on the left denote records broken in Beijing, and the red arrows on the right show records that had been in place for more than two years going into the games.

I'll turn it over to Ross at Science of Sports (and the emphasis is his):

For the men's analysis, the average age of the swimming world records BEFORE the Beijing Games was 680 days. As a result of the carnage in Beijing's Water Cube, it fell to 382 days (because 11 events had their records reset to zero days). There are now only THREE records older than 2 years - the 100m Butterfly (Ian Crocker), the 400m Freestyle (Ian Thorpe) and the 1500m Freestyle (Grant Hackett).

That is staggering. In a very real sense, the sport of swimming is an utterly different place: There is pre-Beijing swimming, and there is post-Beijing swimming. With some races in Beijing having as many as five finishers coming in faster than the previous world record, we have essentially thrown the old rules out the window and started the sport all over again. The authors argue, and I mostly agree, that this is a problem for the sport, and certainly not a symptom of a credible pursuit.

You can, I think, say the same thing in capital markets. There is the leverage-happy super-market that existed prior to September 2008 -- call that the bodysuit period -- and there is the much less levered market towards which we are unwinding today. Many people, however, persist in viewing the world through multiples, techniques and signposts that worked 5-15 years ago, even those belong to an already bygone age. The step function in the market, as opposed to the usual cyclical transition to and then from recession, is what is important here. We discredit capital markets entirely by the jump change, and going forward cannot be smooth, whatever the extrapolation-happy equity-uber-alles sorts might think.

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