A Dash of Insight

A Lesson from Dad

The "Dad" I am talking about is Bill Miller.  No, not the one you already know, although we admire the Legg Mason fund manager.  I lost my Bill Miller last year, but the lessons are still there.  Some of them are quite relevant for investors.  (We did a little father/son bonding at Chez Dash this weekend.  Missions accomplished with only one circuit breaker kicked and a couple of buckets of water.  Dad was smiling.)

A Famous Miller Family Story

Here is a signature moment from the young Bill Miller.  I am quoting the key elements, but the tale is told in more detail in this article, Respect versus Arrogance.

The passing of my father, William H. Miller, last week, and some hours of thought on the road have sparked some introspection.  What we try to do at "A Dash" bears his mark.  In a way, that is strange.  Dad went to war instead of to college.  Growing up in the Detroit area, he understood engines.  The principles are simple:  Fuel, Oxygen, Ignition.  It is amazing how people can get this wrong.

As a sailor on his first ship he found himself in an interesting situation.  The engines had been overhauled, but would not start.  Experienced machinists could not figure out the problem.  Officers were hovering and complaining.  The young sailor asked if he could try something.  There was a lot of skepticism, but he was given his chance.  He knew that the fuel and air were OK, so he removed the spark plug and tapped it on the deck, narrowing the gap.  When the plug was replaced, the engines started!

If you could see a picture of the young sailor, cap tilted at a jaunty angle, you might guess the mixed reaction.  The officers were delighted at a problem solved.  Those in charge of the engines were less enthusiastic.

This story was repeated many times over in his Navy career.  While he never got all of the promotions he deserved, he was a fixture on the boats deployed by his Captains.

No Substitute for Knowledge

A crucial lesson from this is that there is no substitute for actual knowledge about a subject.  It does not matter what your rank is.  It does not matter how many years you have served.  It does not matter how many other people call you "Sir."

If you do not have the knowledge, you cannot make the engine start.

The Investment World

There is an interesting difference between social science and engines.  When a theory about an engine is incorrect, the results show up right away.  When a theory about social science is incorrect, the idea may persist for many months -- even years.

This makes it much more difficult for the consumer of information. How do you know when the engine is not going to start?

Here are some red flags.

Misuse of the word "rigor."  A long causal chain with a lot of unsupported assumptions may seem powerful, but it does not meet the definition of rigorous.  A strong argument begins with an assumption that everyone would share, and then provides evidence at each point.  The longer the chain, the more evidence that is needed.  Whenever someone makes a big argument about "rigor", make sure that he has some credentials for each step in the chain.  Big hint:  Rigor usually means peer review.  Those with thin skins about criticism of their work are usually not rigorous.

Selection Bias.  This happens when one starts with a pre-conceived notion of the world and distorts evidence to fit the conclusion.  It is a characteristic of many of the leading investment blogs.  Ironically, many of the same bloggers talk frequently about behavioral economics and the dangers.

The "Slick" Factor.  Many of the top-ranking pundits are there because -- well -- because they are top ranking pundits.  They are cited as "friend/buddy/pals" of someone, or called "doctor" or "professor" to amplify credentials.  Most of them are good with sound bites on TV.  None of them could actually start the engine.  Most of these guys have never created a quantitative model, and would have no idea how to begin.  They do not know SPSS from American Idol.  Their charts come from others -- those with a world view they want to sell.  Many become famous by making a prediction that works--eventually.  There is no real accounting of the investment impacts.

The "Big Money" Managers. Statements from the "big-time" fund managers carry a special warning.  Does it really need to be stated that these people always have an agenda?  If a manager has a fiduciary responsibility to clients and a fund, and then gets a spot on TV, what do you expect him to say?  It would be irresponsible and deceptive to talk against his own book.

Conclusion:  Strong Voices are Leading You Astray

Here is Bill Miller's lesson, some great principles applied to investing.

• Don't take some long-winded analysis to be "rigorous."  Check whether the author has the relevant expertise -- research methods, economics, government, etc.
• Check your sources.  It is pretty easy.  If your favorite source dishes up a constant stream of one-sided commentary, you should already know the answer.  You can enjoy reading your source for entertainment, but not for investing.
• Look beyond the "talkers" and check the actual predictions.
• Do not conclude that someone in a uniform with braids really knows how to start the engine.

And finally,  realize that everyone is an expert on something.  Learn to listen instead of pretending that you already have all of the answers.  Be willing to challenge, but do not be arrogant.

Thanks, Dad.

Government Conspiracies and Your Money

At "A Dash" we are amazed almost daily by the haughty and high-handed disrespect from Wall Street when it comes to the everyday workings of government.  So many powerful voices are so confident, and simultaneously so wrong.  This is typical when an expert switches subjects from something he really knows about-- stocks, trading, technical analysis, etc.-- to something he knows nothing about.

CNBC stimulates this with their "guest hosts" who are encouraged to offer an opinion on whatever topic comes up that hour.  Of course, some of their journalists are already participating in that way.  Looking to the frequently-cited wise men, Jonathan Berr runs down a short list, but there are many more good candidates.

When we see the errors, it is a "kid in a candy store" feeling.  Start with a bunch of traders, fund managers, and lawyers.  None has ever developed a quantitative model, and many cannot construct or interpret simple tables or regressions with statistical controls.  They have not taken (or do not remember) the beginning classes in government, economics, statistics, or research methods.

These pseudo-experts cite actual data, developed with great care by the strongest experts, as "a work of fiction."  As if they knew the difference!  Why?  Two reasons.

First, they do not like the result they see.  It does not agree with their own daily experience.  They confuse their own compartmentalized view of the world with reality.  It is also a message they can sell to their audience, often a niche group who share their world view.

Second, diminishing the real experts increases the influence of the pretenders.  If these powerful voices can convince most to ignore data, then anecdotal evidence rules.  It is an alternate data universe.

And the pseudo-expert is also the master of the anecdote.

The most prominent media voices support them.  Why?  It is a good story.   There are very few who choose to educate readers rather than to play to their existing biases.  It is a good business model.  Readers can understand anecdotes, but not statistical methods.

There is a symbiotic relationship between media and the pseudo-expert community.

Conspiracy Theory

Taken to the extreme, the pseudo-expert actually suggests that "government" is acting in a conspiratorial fashion.  It is pretty easy to recognize such superficial analysis.  It is the work of people who have seen too many movies and read too few books.

The biggest red flag?  Look for those who discuss the U.S. "government" as if it were a  unitary actor.  This is seen only in a ruthless dictatorship with a small inner circle.  Those who conclude, for example, that the President is "cooking the books" on inflation or employment data make this mistake.  They do not understand that the actual work is being done by a non-partisan senior executive service.  (Those interested in how government decisions are actually made should consult our summary article.)

A Failed Conspiracy

Actually, conspiratorial moves are rare and for good reason.  Even closely held secrets, like the original Watergate plan, have a way of leaking out.  The recent suppression of the global warming report provides a nice example.  Menzie Chinn at Econbrowser, one of our featured sites, discusses the report that the Bush Administration thought was too dangerous to release, now available after four years.

This Washington Post article shows what happens when the echelon of political appointees tries to tamper with the work of those who serve government regardless of the party in power.

This is an important example to remember the next time someone is selling a conspiracy theory that you should not be buying.

Investment Effect

One of the strongest things an investor can do is to discover information that is poorly understood or appreciated by everyone else.  It is especially ironic that the commonplace viewpoint is offered as "contrarian" by those taking it!

Briefly put, one can gain an investment advantage simply by identifying and believing information from the real experts on various economic topics.  How simple!

Where to start?  Here's a hint.  The "government" as represented by the diverse Congressional and bureaucratic interests has no unified position about the measurement of inflation.  Many members of Congress, for example, would like to increase Social Security benefits and labor cost-of-living increases.  They would be happy to see inflation measurements that would aid these constituent groups. The BLS employees have tenure and are not subject to political pressure.

Meanwhile.....

Big-name fund managers like Bill Gross have a strong financial interest in public perception of inflation and the economy.  Like any smart manager, he talks his book.  Should you be listening?

More later on Bill Gross versus the BLS, now in its fifth year, but still playing on a blog or TV station near you.

Investors Look at the Wrong Information! Why?

It is difficult to beat the market.  Individual investors who try to do so have, on average, results that are decidedly inferior.  And not just by a little.  It is more like half of the market return.  They try to time the market using all of the wrong methods.  They are afraid when they should be active.  They are "all-in" when they should be cautious.

We are developing some general themes -- common mistakes -- but our effort is one of building the case a step at a time.

An Example

Before departing on a long weekend of pure relaxation, we tried to leave investors with an insight that we felt was particularly valuable.  Our experience shows why getting perspective is important.

Earth to OldProf:  They do not get it! We posted an article on why accounting rules may be misleading investors.  We know that this is important for several reasons:

1. It affects all of the financial stocks, an important key to the  market;
2. General understanding of the issues is poor and reflected in the prices of many stocks:
3. The financial write-downs get plenty of daily play, with each new story changing analyst estimates.
4. The crucial element of understanding requires knowledge of accounting rules, the immediate effect, and the longer-term implications.
5. The big mainstream media sources report each fact, but often do not provide an analytic framework.

With this in mind, we wrote about how the rules affected a key company, AIG, and the market impact.  Quite frankly, we hoped and expected that this would generate some interest and comment. Wrong! What were we thinking?

We checked this with our own small focus group and got a big yawn.  No one wants to think about FAS 157.  It is over the barrier of complexity.  If things get too technical, everyone tunes out, no matter how important the topic.

The focus group was correct.  We pay little attention to daily traffic at "A Dash" since we are not doing advertising, but we do periodic checks to see what resonates.  FAS 157 causes eyes to glaze over.  No one cares.

This myopia is empowering for those who take each issue to the lowest common denominator.  FAS 157 was a big story when the bearish bloggers saw last November 15th as a doomsday date like Y2K.  When it did not happen, the powerful writers in mainstream media did not point this out.  There is no accountability.  It is easy to make big predictions of write-downs.  And it is newsworthy, picked up by all of the popular media sources and financial television.

Conclusion

There is always a way to appeal to an audience without providing understanding.  Realizing this is the biggest challenge and the biggest opportunity for investors.

The credit market issues are difficult to understand.  Investors and traders are not really capable of making independent decisions.  Even if they work to get the facts, it also requires a solid analytical framework.

We shall pursue this with some other examples.  Meanwhile, we need to work on article titles!  Maybe if we had called the article DOW 15000 and included the Sports Illustrated swimsuit indicator, with a picture or two, it would have gotten more attention.

Understanding why FAS 157 is important is both more important and more challenging.

Distinguishing Opinion from Analysis

At "A Dash" we have been exploring the question of how an intelligent individual investor might gain useful information from the media -- both print and broadcast -- and from the rich offerings of the Internet.

A main theme of our planned book is that a little knowledge can be a dangerous thing.  The average person, a consumer of this information, needs to understand the qualifications of the source.  The consumer must have enough knowledge and technical skill to decide how to interpret the commentary.

An important theme is that the democracy of the Internet and the hunger for content has diminished quality.

Background

A viewer watching CNBC today was offered a discussion on a possible bailout of Bond Insurance companies[no link yet].  The discussion, emphasizing whether such a bailout was desirable, included someone who is expert on analyzing individual companies and is now expanding to offering opinions on everything, the CNBC technology and media editor, and the go-to guy on the inner thinking of Wall Street.

Since we were intrigued by what this group might have to offer, we took CNBC off of the standard "mute" and TiVo'ed back to the discussion.

What we heard was the opinion of three people, all nice guys that we would enjoy having lunch with or chatting with over a drink after work.  It was opinion.  It leaned to the idea that government should allow the free market to prevail, that economics suggested that the chips should fall where they may, and that businesses and investors who made poor decisions should accept the consequences.

Who Knows What?

Let us suppose that one heard two different people talking about playing the violin.  Each described the emotion and passion of a performance, the feel for the music.  Both people "talked a good game."

Let us next take a further step.  Suppose each was asked something quite different -- asked actually to play!

There are many "pretenders" in financial commentary, something that we discussed in some detail a few months ago.  It is worth reading again.

Key Questions

There are several questions to ask.  The short list is as follows:

1. Was it clear that this was an "opinion" segment?  In mainstream media, opinion columns appear on an op-ed page, clearly identified as such.  A consumer is alerted.  Television and blogs alike highlight these opinions without such identification.
2. Was the presentation balanced?  The answer to this is a clear 'No."  We hesitate to make statements referring to things like "one learns this in (pick your subject) 101", since most people saying such things seem not to have taken Subject 101 themselves!  Our commentary is a bit different, based upon experience in teaching Poli Sci 101 at a major university.  The problem in the discussion is that the participants had no awareness of the role of government, something taken up in an early lecture.  Since we cannot do the entire class here, let us just make the major point.  Government engages in a "bailout" not to help the affected groups, but because of a threat to innocent parties -- collateral damage, if you will.  If the systemic risk is great enough, it is appropriate for government agencies to act.  They do so not because they are helping those who made mistakes, but in spite of it.
3. Did the information make clear that the opinions offered might not be predictive of actual government action? Once again, the answer is "No."  If one really understands the mission, norms, and motivations of various government agencies, it is clear that what will probably happen (and already has happened) is in direct conflict with the opinions offered.

Investor Relevance:  Normative versus Empirical Thinking

Abnormal Returns, always a great source for what is relevant in the financial blogosphere, sometimes provides a thoughtful article giving additional perspective on key information.  We found the discussion of positive and normative economic theory to be especially useful, and urge readers to check out the complete article.  What is stated about economic theory is equally true for political theory.

Investors should be most interested in what government agencies are likely to do, not in opinions about what someone on TV thinks they will do.

Our Take

The issue of the monoline insurance companies is a key question for markets, as we have noted.  The process of "solving" this problem seems very slow to market participants.  Daily trading reflects each twist and turn.

This problem will be addressed, either through private action or more aggressive moves by government agencies.  The reason is simple.  There is so much systemic risk.

Our opinion does not mean that specific companies or their investors will profit.  In fact, the solutions may involve major dilutions of interest.  Government is less interested in saving investors in the individual companies, but much more interested in stabilizing the economy and the markets.

Consumers of information must always distinguish between those who offer opinions about what they believe should happen, and what is actually likely to happen.

There are many applications of this principle where those with opinions have already been proven wrong, including Fed interest rate actions, the TAF facility, the stimulus package, changing conforming loan limits, and relief for individual homeowners.

These actions should be viewed collectively, not as individual policies.

Financial Blogs versus Mainstream Media: Dealing with Mistakes

Those seeking financial information online have important choices to make.  Many are shifting from financial newspapers and magazines to the online versions.  This is still mainstream media (MSM) but in a different form.  Some are also finding the rich diversity of opinion available through financial blogs.

An Interesting Case

Felix Salmon's Market Movers blog at Portfolio.com highlighted on Monday some glaring errors in a New York Times article about Maria Bartiromo.  He writes again today concerning how the errors were fixed.  We strongly agree with his conclusion about the "shallowness of the NYT's bench when it comes to business coverage."  We also agree that the quotations used do not ring true.

The Implications

In September we cited and discussed research suggesting that blogs were somehow less credible than MSM sources.  A traditional test of credibility is accuracy and the willingness to correct errors.  In regular publications or news broadcasts the correction is made in a way that attempts to reach the same audience that saw the original error.

In the blogosphere this is more difficult.  Readers have an agenda that covers occasional articles from many sources.  The original stories get more recommendations and buzz than do the corrections.  Some people may not even see the corrections as important.  Using the NYT example, suppose the errors occurred in someone's blog.  Who would care about getting some names wrong?

Felix Salmon's article highlights the gradual erosion of confidence that occurs where sources are not careful about the information in their work.  Corrections help, but only partly.

Investment blogs draw strength from their freewheeling nature.  It is also a potential weakness.  The difference between MSM and blogs may narrow in two ways:  bloggers may improve error correction while MSM sources get sloppier!

Test Your Skill: Interpreting Economic Commentary

How good are you at interpreting economic commentary?  What if the statement is strictly factual?  Can you tell fact from fiction?  If not, you are poised to lose money to those in the know.

Interpreting Job Growth

The non-farm payroll report is one of the most important economic releases, with massive swings in both stocks and bonds in the balance.  Crucial to the interpretation is the following question:

What is a good number?

A "good number" might be one that sustained an acceptable rate of unemployment, perhaps the current rate.  One might expect this to be a factual matter, upon which everyone can agree.

That assumption would be incorrect.  In fact, there is controversy on this topic, with a significant disparity among the leading pundits.  This is important because it influences everyone's thinking about the general strength of the economy and the consumer.

If you do not get this right -- either way -- you may be making poor investment decisions.  Here are four different sources on the topic of what rate of job growth is needed to sustain the economy.

See if you can figure out which source is most reliable.  We recommend to readers our LINQCRED method to make sure that you do not miss any information.  Please do not click on the links until you have finished the test.

Source A

The number of people in the US keep growing: 300 million, with a very high birth rate for an industrialized country, lots of legal and illegal immigration. If  the population grows near 1%, that's 3 million new people in the USA each year. Almost two thirds are working folk -- immigrants and recent grads. (grads coming into the labor force are equal to a percentage of newborns)

Do the math, and you find that the economy needs about ~150,000 new jobs merely to keep up with this population growth.

Whenever you hear someone on TV describing 110,000 new jobs as "robust, you know you are watching someone who is either a) innumeric; 2) an idiot; iii) a liar; IV) some or all of the above. 

Source B

And once again, The Street and their fin media stooges bray about how bullish 132,000 NFP jobs are (CSFB’s chief economist called the report ‘excellent.’) even though just a few years ago Street Conventional Wisdom held that the economy must generate about 175,000 jobs each month just to absorb demographic growth.

Lehman’s economist said, “The labor market is one of the stronger parts of the economy right now.” This is a Clintonesque, qualified statement. It could imply that the rest of the economy really sucks.

Source C

[interpreting the average job growth over the last few months] ...(S)ince the increase in the labor force is closer to 120k  per month this 73k average private jobs for the last 3 months represents a relatively weak job creation.

Source D

[after discussing factors affecting the retirement of "baby boomers" and how this affects those wanting jobs]  If the labor force participation rate remains at its current level, then what might be thought of as the “equilibrium” growth rate of payroll employment--that is, the increase consistent with a stable unemployment rate--would be about 140,000 per month.  However, if the labor force participation rate instead declines 0.2 percentage point over the next year, as suggested by the Fed’s staff research, then the comparable equilibrium payroll employment growth would be closer to 110,000 per month.

Solution

We hope that the wise audience of "A Dash" could figure this out without LINQCRED, but the discipline of a method often forces one to think.

Source A is Barry Ritholtz.  Barry has made a simple calculation without taking any account of changes in the labor force.  We want to be completely clear:  We are long-time and big-time fans of what Barry does.  Like everyone else, we read his blog daily.  We urge Barry to take note of an important demographic fact:  BABY BOOMERS.  The first one recently applied for social security.  Their retirement patterns dramatically affect the labor force.  If The Big Picture is to remain relevant on the analysis of employment trends, it needs to include dynamic analysis of the labor market, not just averages of past values.

Source B is Bill King of Ramsey King Securities.  We do not know what credentials he has, except that he writes a private market letter that  gets a lot of publicity.

Source C is Nouriel Roubini, an economist at NYU and a frequent source of bearish analysts.

Source D is Susan Bies, who was a Fed Governor at the time of the quotation.

Conclusion

Readers are free to form their own conclusions, but our money is on Roubini and Bies.  Despite this, you can expect next month's commentary to use 150,000 jobs as a benchmark, fostering the notion that anything else is weak.  We have a long list of those who use this (mistaken) value, and we add to it daily.

We are pursuing on ongoing theme that inaccurate information and analysis is rife on the Internet.  It is very difficult to correct.  Internet pundits can say anything they want, and there is no check.  Those who act as the "gatekeepers" of the Internet frequently do not give the same visibility to refutation as they give to the original assertions.  This is an important difference between mainstream media and the blogosphere.

Other examples of non-farm payroll employment errors can be found here.

Embracing Information

How can the individual investor find and interpret the best sources of information?  The Internet is rich with material.  Is it too rich?

Investors have so much information that they cannot read it all.  Suppose you are an individual investor, encouraged by television advertising to make your own decisions.  You look at the list of the leading financial blogs and start reading.  Many of the sources highlight each new data point, encouraging the investor to make decisions on this basis.

This is fine if the investor has a perspective on fundamentals --forward earnings of stocks compared to the principal alternatives -- bonds and real estate.  Lacking this perspective, the potential investor in stocks gets a plethora of repetitive information about what is wrong.  Not all economic indicators are reflected.

Most readers do not follow the LINQCRED method that we recommend.  They read headlines and interpretation without doing their own analysis.  They also do not question the expertise of those interpreting for them.

A Case in Point

Last week we met with a potential investor, typical of many with whom we talk.  We discussed our  programs -- one based on fundamentals and the other based on system trading.  Both have strong records versus the S&P 500 for our history of nearly ten years.

The potential investor likes to read things online, and made a revealing comment.  He said, "I like to keep track of the things I should be worried about."

This is the key.  The investor is not looking for opportunity when everyone is worried.  He is joining the worry.  Those reading Internet information must have a framework for analysis or they will certainly go wrong.

An Objective Source on Housing

Anyone paying attention knows about housing problems. The Bearish Broadcasting Network, which we recently spoofed, makes sure that each new data point gets plenty of attention.

 A source that is on our featured list of blogs, Matthew Padilla, is writing from Orange County, the epicenter of these issues.  We like to read his work because of the consistently objective focus on data and the helpful orientation of the columns.  Some entries have been quite negative.  The following recent stories are more hopeful:

• A story on foreclosure trends.  The headline is that month-over-month there is a 5% decline.  Foreclosures are still up 469% over last  year.  Take a look at the table in the article.  Which view provides new information?
• A story on the decline in ARM mortgages.  There are plenty of resets to come, but this is still new information.  Once again, look at the helpful chart.
• A story on the improved credit profile of Orange County residents.  This means that there are qualified buyers, when and if the credit freeze-up gets improved.
• A story on the decline in mortgage rates.  This will help those trying to refinance or to afford new purchases.

Conclusion

There are potential buyers for homes.  They may not qualify for the same level of loans that they did a year ago, but the bidders are there.  Prices need to decline to clear the  market.  This will happen -- gradually -- as mortgage lending conditions improve and sellers make realistic offers.

Everyone understands that there is a housing problem.  The questions are how quickly it will be resolved and what needs to happen to get there.  When businesses have a high inventory, they clear it by reducing price.  The process of price discovery in housing will eventually happen.

Meanwhile, the information on the impacts for investments in stocks seems heavily tilted, reflected in the heavy discount of stocks compared to bonds or cash.

LINQCRED: A Hedge Fund Manager

Yesterday we revealed our disciplined approach to interpreting information.  It is actually quite simple, but we already have some complaints.  Too complicated.  Too many steps.

Investors and traders who want to gain a real edge must be willing to do a little work.  This is a good test.  If you are not willing to employ a careful process of critical thinking when evaluating information, you should just buy an index fund and move on.  Those who are willing to do the work can beat the market by several points each year.

Learning by Example

The best way to learn -- and really learn right -- is to study examples until you get them all right.  Earnings season is a great time to do this.  There is plenty of anecdotal evidence and interpretation.  We read and analyze them all, but this series of articles will try to provide some illustrations from varying perspectives.

Background:  Observers and Data Analysis

One of the most important aspects in interpreting information is understanding the expertise of the observer.  At "A Dash" we like to look outside the investment world to help readers see the point.  Then we come back to an investment application. 

The Numbers Guy has a great article on streaks in baseball.  This is a worthy topic for another day, but we were struck by the following comment on one of the most astute baseball analysts, Tim McCarver:

Streakiness and momentum aren’t the only tenets of conventional baseball wisdom to collide with math. Fox analyst Tim McCarver expressed surprise during the Red Sox-Indians series upon learning that multirun innings are more likely when the leadoff batter hits a home run than when he walks. His assumption was that a runner on base affects the pitcher and batters psychologically, leading to a rally and multiple runs, while a leadoff home run makes everyone start with a clean slate. But the numbers show that it’s easier to get one more run with the bases empty, than getting two runs when starting with a runner on first base. Mike Kellermann, a Harvard graduate student, rounded up the reaction from blogs and showed that historical numbers side with the homer. Meanwhile, sports-statistics company Stats Inc. told me that in the 2007 regular season leadoff home runs led to multirun innings 28.4% of the time, compared to 27.2% of the time for leadoff walks.

The point:  Impressions, even by the best experts, are inferior to analysis of the data.

Example:  A Good Hedge Fund Manager

Erin Burnett, who is asking opinions about recession of anyone in front of the microphone, interviewed a good hedge fund manager in one of CNBC's new segments yesterday morning.  There is no point in naming the manager, a very sharp and engaging man who embarked on a trading career right out of college, and who now has his own fund.  We know many people just like him, and believe his perception and approach to be quite typical.

The key question and answer were as follows:

EB: You can sit here and argue persuasively for a recession or against a recession ----

RS: A lot of the evidence that argues against the recession is backward-looking and a lot of the evidence that argues in favor of it is forward looking. Until we get more data it’s going to be hard for this to sort itself out. …Friday I was particularly troubled by a note from JP Morgan … which downgraded Ford and GM credit because of rising delinquencies in the prime auto market. As you start to see evidence that this is expanding beyond the sub-prime homebuilders you have to become more and more in the camp of recession. I’m not optimistic that years and years of financial excess can be wiped away with a couple of small funds and a couple of moves here and there…..we are headed toward more difficulties.

Implementing the Method

After reading the information carefully, we readily see that it involves interpretation and analysis of information disseminated in the  market last week.  The novelty, step "N" in the method (LINQCRED), depends upon the interpretation of the data, not the data itself.

Turning to Qualifications, we have no idea about the success of this manager in making global macro calls of this sort.  He is someone who got an interview on TV.

Turning to Competence is a crucial point.  The interview subject seems to have begun with a viewpoint about the markets and market history.  How does one know the extent of "financial excess" or how long it might take for this to be resolved.  We have had a period of below trend growth in GDP, intended by the Fed?  How much will be enough?

Most importantly, has this observer really studied what types of data are backward-looking and what data provide a leading indicator?  Do rating agencies look forward or do they look back on past results?  [This is rhetorical question.  Rating agencies are obviously deciding on recent performance.  That is past data.  Is there evidence that it is predictive?]

Conclusion

This observer in our example has a viewpoint and reads the news carefully.  In a known and planned period of reduction in economic growth, to fight inflation expectations, we see such data every day.  If one begins the day by looking for it, it will be there.

Our example observer spends his day trading and running his fund.  He has not done an analysis to determine which indicators lead and which do not.  It is an opinion, and one that lacks face validity.

Compare this approach -- typical among traders and hedge fund managers - with those who specialize in taking data from all sources to make forecasts -- like the ECRI.  There is a difference between those who study indicators to find those that lead, and observers who begin with an opinion.

Following the LINQCRED method carefully should warn the investor about embracing this conclusion -- even if CNBC decided to feature the comments.

Using Inside Information

One of the first things that any trader or fund manager needs to learn about is insider trading.  The most important lesson is that it is illegal, and anyone doing it might go to prison! So don't do it.

Over the years, most such tips we have heard (and rejected) were losers anyway.  Insiders often do not know how news will affect the market.  Their big ideas and plans are frequently not embraced by the investment community.

At "A Dash" it is not our mission to help readers to commit a felony by trading on material non-public information.  Instead, let us look for material public information -- the legal type that most others miss on a systematic basis.

In this series of articles we will describe how to use information.  This is at the core of our work, and these articles will reveal how to do it and provide some examples. Readers who follow the entire series may not realize the power of these "secrets" because we hope to make it seem obvious.  The information is hidden in plain sight.

Two Types of Investor Errors

Let us begin with an oversimplification.   We shall add some qualifications later.  There are two basic types of errors.

Type 1:  Believing the big guy. The "big guy" may be very rich, a legendary investor, a noted columnist, a leading blogger, or a celebrity on financial television.  The big guys make a lot of mistakes -- glaring ones on occasion -- but these usually go unnoted. Interviewers do not ask the tough questions.  Outside commentators in the blogosphere may not engage in criticism.  If they do, their comments often get less attention.

Type 2:  Neglecting the little guy. The "little guy" can appear in many forms.  It does not require a PhD to observe and report important facts.  Valuable insights come from many places, and these are often overlooked.  The information used by many includes bias against certain sources, including those in government and stock analysts. We shall discuss how to use this information to gain a significant investment edge.

The Method,  LINQCRED, will seem simple, because it is. The value comes because so few use critical thinking skills in evaluating data. The steps are as follows:

• Listen. Or read, as the case may be. If the observer is busy being critical because the information does not fit his/her pre-conceived notions, there is no chance of learning. One learns by listening, not by speaking.

• Information. Is the new information data or analysis? This is a crucial step. Does the source provide specific relevant information or is it an interpretation of data available to all?

• Novelty.  Does the information really provide something new? If not, does it provide significant new data to support an important market hypothesis?

• Qualifications. Is the source authoritative on the specific subject in question? If the information consists of data, is the source an accurate reporter? If it consists of analysis, does the source consistently follow an analytic method that has a proven record?

• Competence. Does the observer have the skill to evaluate these questions? If the information consists of data, can you make the key distinctions between new data and redundant information? If it is analysis, do you have the methodological skill to review the conclusions? This is the most difficult point, and the most important. It is a place where many investors stop thinking and rely on perceived authority.

• Review. Any good method requires checking. The investor should review each of the steps, carefully checking reasoning and conclusions. Think carefully before acting!

• Evaluation. Good information leads to a specific investment decision. This means a careful evaluation of the impact on expected earnings compared to alternative investments, with consideration of risk. Earnings, alternatives, risk. Those are the fundamentals.

• Discipline. Having reached a conclusion, the investor must have confidence in the method. Warren Buffett buys good businesses at good prices. He is not dismayed if the market disagrees.  He buys more! The investment conclusion is based upon facts, not the current opinions of others in the market. If the facts change, you should change. If not, the investor must not react emotionally. Investment decisions will rarely result in buying the exact bottom or selling the exact top. That is not needed for success.

Conclusion

The emphasis on the “big guy” can be checked by reading about the current media frenzy to find the big story.

Readers who think they are skillful in analyzing experts should check out their quantitative IQ. The example provided leads to an important market conclusion, widely disseminated on the Internet, and difficult for many to interpret.  The popular conclusion is completely wrong.  Despite this, only a few experts have given us a correct answer.