Yet history also shows that relatively few investors are willing or able to act on this information in a timely manner. Some analysts say that's a sign of irrationality. Perhaps, although the future is always at risk of playing out differently than what history implies. Cochrane recommends taking the contrarian route only if you can afford to take risks that the crowd can't or won't take. "We can't all be smarter than average," he says, "but we can all find a piece of risk that we're more willing to bear than somebody else."
Locating one or more of those pieces isn't necessarily the problem. Financial research has made great strides in identifying those times and conditions when certain slices of risk appear to offer superior (or inferior) return-to-risk ratios. But turning this information into realized risk premiums is still hard, and it always will be. The human mind, it seems, is as much a source of progress in finance as it is an impediment to reaping the rewards. That dual nature is probably the reason the economic cycle is in no danger of extinction and risk premiums will continue to fluctuate dramatically.
James Picerno is a freelance writer and author of Dynamic Asset Allocation.