Interpreting data requires special skill and training. Hardly anyone has developed these skills, but that does not stop them from offering opinions. Here at "A Dash" we have highlighted some of the most popular errors. Today provided some examples.
This is America! Let the games begin....
Public Opinion on Stimulus Plan? Thumbs Down!
It is the six-month anniversary of the passage of the stimulus plan. This was a classic political compromise. Any and all observers could criticize the plan. The symbolic language -- shovel ready -- conjured up the wrong image. The announced plan suggested that there would be a lot of visible jobs from construction. The actual plan relied upon macro-economic spending principles, and was scaled out over two years.
The unsurprising result is that the economy has still not recovered and most Americans believe the program is not working. This includes plenty of intelligent people and Obama supporters. To understand the impact, one needs to grasp the concept of the counterfactual (which we explained in easily understandable terms here) and the economic impact of policies like helping the states and extending unemployment benefits.
Anyone who understands economics knows that the stimulus has already mitigated a difficult situation. It is to the political and personal advantage of many to attack the program.
Pundit Opinion on the Economy
Most of the punditry understands behavioral economics. They know all about confirmation biases and the temptation to see each data point as support for a pre-conceived idea.
It makes no difference.
The market is looking hard for signs of economic growth, reacting to each twist and turn of the data. Participants are missing the big lesson: What constitutes normal progress in an improving economy.
It is unrealistic to expect each economic indicator to show progress in lockstep. The data will provide mixed signals -- partly because of differences in sectors and partly through measurement errors. If one chooses to look at the worst news or find the worst interpretation of data, one can be in denial for a long period of time.
It is all about finding the best indicators in an objective fashion.
What is Normal?
In our summer quiz, we highlighted a question about data interpretation which few understand. We ran this article in June. We expect that our quiz questions will eventually be recognized as the key market issues.
Here was Question #1.
We have an honest coin which we flip 20,000 times. We keep a running count of whether heads or tails is in the lead. How many lead changes would you expect? (A good ballpark answer could be the winner here).
In his excellent book The Drunkard's Walk: How Randomness Rules Our Lives, (now added to our recommended list) Leonard Mlodinow explains how people -- smart people -- fail to understand data because they do not understand probability. His example involves a test of two movies, but the application is equally valid for many applications. Two theories, two investment managers, two pundits.....
He writes as follows (page 14):
Because the coin has an equal chance of coming up either way, you might think that this is experimental box office war each film should be in the lead about half the time. But the mathematics of randomness says otherwise: the most probable number of changes in the lead is 0, and it is 88 times more probable that one of the two films will lead through all 20,000 customers than it is that, say, the lead continuously seesaws. The lesson is not that there is no difference between films, but that some films will do better than others even if all the films are identical.
Mlodinow is a physicist who has written for popular entertainment like Star Trek and MacGyver. He is excellent at making difficult concepts accessible to average intelligent readers. He provides many other examples of normal random data, consistent with the work of the behavioral economists.
The key here is that a concept in the lead (the weak economy) will seem to retain the lead.
We have attempted to highlight the important indicators. -- ECRI, initial claims, and the ISM -- and we will work to highlight others. These important measures have been positive. Many other measures that we follow -- employment, Michigan sentiment -- are giving a negative signal.
For stocks, it is all about earnings. Bearish pundits dismiss the last round of earnings because the results were based upon cost-cutting rather than revenue growth. (What would they have said if earnings had disappointed?) We believe that revenue growth will soon follow with stimulus impact. Companies that have good cost control will show good earnings gains.
Meanwhile, those emphasizing trailing earnings can fixate on forced write downs from last year and the post-Lehman cessation of normal lending. These pundits will miss the resumption of normal and sensible lending. It is time to look ahead for opportunity.
Or one can fixate on last year. Your choice.