At "A Dash" we often find that examples from the world of sports can help investors understand crucial concepts. One such concept, abstract and elusive, is "the counterfactual situation." This describes what would have happened if a specific event or decision had not taken place.
Take the recent British Open golf championship as an example. Even marginal fans were attracted to the story of Tom Watson and his near victory. Watson is an all-time great, the winner of eight major championships. At age 59 and playing with an artificial hip, he is not expected to compete with those in their prime.
On the 72nd and final hole of the tournament, Watson needed only a par score, four strokes, to win. He hit a beautiful drive. He hit an eight-iron to the green, a perfect stroke that was a little too much club. Putting back from the fringe, he left himself with a ten-footer to win. This was the putt that missed.
More than 30 minutes earlier Stewart Cink had dropped a crucial birdie putt on the same hole, setting the stage for Watson. This was the "putt made." In the ensuing four-hole playoff, Watson seemed to tire and Cink dominated to win by six strokes.
The counterfactual is easy to see. If Watson had made his putt on the 72nd hole, or Cink had missed his, the result would have been different -- and a huge story (even more than it was).
In sports, it is sometimes easy to see what would have happened in the absence of a particular event.
For investors, the counterfactual is usually more elusive. In the market and in the economy, it is often difficult to figure out what would have happened if a key element were to be changed. Here are a few current examples:
- The stimulus package. Political opponents want to call it a failure. Supporters point to how bad things would have been without action. Who can tell?
- Cash for Clunkers. Is the program stimulating new sales, or pulling future sales into the current time frame? Will it change economic and investment psychology? Who can tell?
- Lehman, Goldman, Bear. Everyone has an opinion and a book. Would a different policy have saved Bear Stearns? What if the government had not allowed Lehman to fail? Goldman now looks strong, but could it have failed as well. Some analysts think so. Who can tell?
- Financial bailouts. Many banks got TARP funds. Some say they did not need the help and many are repaying. Was the government action timely and necessary? Who can tell?
Many people claim to have an answer to these questions, but few have a strong analytical framework. Most are starting with a political viewpoint. For them, the answer follows easily.
For those of us trying to find good investments, no matter which party is in power, it is more of a challenge.
This key concept will be part of many future articles. It is at the heart of much of the current policy debate.
We discussed the counterfactual, Alan Greenspan, and housing in this story:
We analyzed the counterfactual concept, with examples, in this piece.