A Dash of Insight

Getting beyond the Rhetoric

Readers of "A Dash" constitute a sophisticated investing audience.  We know this both from comments and from email.  Perhaps readers will take some time to help in our key mission -- the blog about a book.

Imagine that you are an individual investor who got  your January statement and discovered that your broker's advice cost you money.  Swayed by the frequent TV commercials from online brokerages, you now think that you can do better than your advisor (or an index fund) taking only a few minutes of your spare time.  If you are really ambitious, you can spend an hour or so and develop a complete trading system -- according to a leading firm.

Since there are so many Internet resources, that is one of the first places you look.  Perhaps you follow someone's list of the blogs getting the greatest traffic.  It is like finding a restaurant with a full parking lot.  Perhaps you look to the resources of well-known brand names like Forbes or the Wall Street Journal.  Perhaps you discover some "gatekeepers" and read the suggested sources.  Most likely you read plenty of online news articles.

Where does this search lead?

Your search gets a lot of information -- most of it using some loaded language about recession or stagflation.

Recession Prospects.  There is a vast disparity between the projections of economists (perhaps flawed, but data-based and professional) and the perceptions of non-economists.  The latter group includes CFO's, CEO's, and your average citizen.  An interesting question is why there is such a large gap?

One answer could be that economists are hopelessly out of touch.  (This idea is favored by bearish pundits who lack any economic credentials!)  It proves to be wrong, since poll respondents are consistently more optimistic about their own situation than they are about the general economy.

There is an excellent, wide-ranging survey piece by Nathan Burchfiel, that covers most of the key perspectives.  He shows the lack of balance in many high-profile media pieces.  He then provides insight from two very well-placed sources:

 CNBC’s Maria Bartiromo said recession “is all psychological. Because when people have fear and expectations that things are going to worsen, they pull their spending. They slow down and become cautious and then they actually push into one anyway.”

 

 Media outlets largely fail to recognize their role in paving the way toward recession. With incessant negative reporting, dotted only sporadically with positive reports, the media are contributing to consumers’ fears. But analysts recognize the correlation.

 

 “We have to hope that the consumer doesn’t decide there’s a real recession coming because then they’ll close their pocketbook and we’ll really have one,” Bill Seidman, an NBC financial analyst, said on the January 10 “Nightly News.”

Journalism?  At "A Dash" we have the highest hopes for journalists.  Anyone wishing to learn about markets, as we did twenty years ago, could benefit from reading daily the best journalistic work.  Is this still true?  Rich Karlgaard argues that the pay is not enough to attract the best talent.  We hope that he is wrong, since most of us depend upon leading journalists to discriminate wisely among sources of information.

Behavioral Finance.

Readers of "A Dash" probably think they are impervious to the barrage of misleading and symbolic language from the media.  We would love to conduct a survey, but the result is already known.

We are all subject to the effects of behavioral finance -- even if we know the literature.

Take this example -- one of so many psychological studies.  We have read all of the books, but the Wikipedia summary serves our purpose here:

The anchoring and adjustment heuristic was first theorized by Amos Tversky and Daniel Kahneman. In one of their first studies, the two showed that when asked to guess the percentage of African nations which are members of the United Nations, people who were first asked "Was it more or less than 45%?" guessed lower values than those who had been asked if it was more or less than 65%. The pattern has held in other experiments for a wide variety of different subjects of estimation. Others have suggested that anchoring and adjustment affects other kinds of estimates, like perceptions of fair prices and good deals.

Is any of us resistant to the media blitz on recession chances, the housing market, and financial write-downs?  Is it any wonder that those not looking at actual data see things much worse than those who do?

Articles that show a minority of economists predicting recession routinely feature the headline, Economists see Recession.

Today's Story: Stagflation

There are so many examples that we suggest a reader test instead of picking on a single source.  Type "stagflation" into Google.  Then read the article.  Try comparing current conditions -- relatively low interest rates and low unemployment with the actual stagflation of the  70's.  We modestly suggest that an individual investor is not likely to see the difference, providing an advantage for those who can.

Symbols are powerful.  Media sources -- mainstream and bloggers alike -- get plenty of traffic by emphasizing the negative.  The popular theme today is the familiar one:  The Fed is in a box.

How to Predict Government Policy

The astute trader or investor should not ask the question of what he or she thinks the Fed will do.  The superior approach is to look at the actual reasoning process and actions of key policymakers.  Is it not better to predict what government will do?  (Readers should check out this article and also the thoughtful commentary at Abnormal Returns.)

A leading source for understanding the Fed is Bob McTeer, whose blog is featured on our site and should be getting more attention.  McTeer explains in detail how he views the issues--a good clue for current FOMC members.  His key conclusion is as follows:

To summarize, in 2008 we have greater wage- and price-flexibility than in the 1970s, fewer cost- and wage-push forces, more deregulation, a wizened Fed, more energy efficiency, and, not mentioned earlier, more globalization imposing price and wage discipline.

While inflation has crept up to uncomfortable levels and the real economy slowed in the 4th quarter, I doubt that stagflation in any serious way is in the cards.  Given the differences I've cited above, that's more than just a hope and a hunch.  But it's that too.

This is an honest answer, and one likely shared by the current FOMC.  Check  out his complete article to learn about how the Fed views inflation potential and which money supply indicators are important to them.

Conclusion

At "A Dash" we are better at analyzing fundamentals of earnings and interest rates and predicting government actions than we are at predicting the behavior of the investing and trading public.  The situation reminds us of the 1999-2000 bubble era, now in reverse.  We are also reassured by the system signals from our trading models, including The Gong, which provided a good risk/reward signal a few weeks ago, and our TCA-ETF system, which is fully invested.  A free report on both methods is available on request.

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.

Media Competition: The Erin Burnett Effect

Successful investing -- or trading -- requires a method and discipline.  This often means knowing how to interpret information and reacting to changing prices.

For many months the key issue has been the prospect for a recession.  Many individual investors and hedge fund managers expect the worst and look at estimates of forward earnings with skepticism.   Friday's market decline, which will be extended tomorrow at the opening according to overnight futures trading, is mainly a reflection of this concern.

Two Approaches to Forecasting Recession

The bearish camp points mostly to problems in housing.  These  pundits argue that housing problems will affect employment directly, other businesses indirectly, and consumers as well since they view consumer spending as fueled by borrowing.  These observers predict with certainty.  They profess to know what will happen.

The consensus of economists continues to see recession chances as about 35%.  This is somewhat above the normal odds of 20% -- since an economic shock can create a recession at any time.  In a time when the Fed has intentionally attempted to create below trend economic growth, fighting inflation expectations, the recession odds will be somewhat higher.

Consumers of Recession Forecasts

At "A Dash" we are a consumer of recession forecasting since we do not have  our own model.  With the exception of a few professional economists, our readers are also consumers of forecasts.  Most consumers make a serious mistake.

The bearish argument is easy to understand in plain English.  It has a logical appeal, since all of the pieces are stories that the media highlights on a daily basis.

The economic argument cannot be understood by an observer without economic training.

This disparity is exacerbated by a general tendency among pundits and bloggers to disparage the results from economic forecasting.  We have tried to explain the error of this -- certainty versus edge -- but it is a difficult concept to grasp.

The Media Background

Some months ago, CNBC lost Liz Claman.  She had to wait out a non-compete agreement, but her plan was pretty clear.  Liz Claman has good ties to Warren Buffett.  She earned that relationship through respect ("Mr. Buffett"), charm, and an engaging style.  She wrote a book based upon her work.

When the Fox Business Network was announced there was aggressive competition for interviews during the launch week.  Buffett was a prime target, and CNBC lost, seething at the result, according to one report.

Friday's Trading

The market opened down about 0.65% on Friday, and Caterpillar opened down less than three points before rebounding.  CAT revenues were in line.  Earnings were about 2% light since they (once again) did not push to raise prices and the forecast for 2008 was reduced about ten cents -- something that was already widely expected.  [Full disclosure:  We are long-term holders of CAT and big winners.  If they are growing revenues and earnings at a 10%+ pace in negative times, we see big things and a higher multiple.]

The Erin Burnett Effect

CNBC viewers were treated to an in-person interview with Elaine Garzarelli.  She was on the program because of her prescient forecast of a market crash twenty years ago, before Black Monday.  Over the next few years, she seemed to lose prestige, although her quantitative method is quite strong.  She explained why she was very bullish on the market based upon fundamentals, with sentiment as the only "neutral" factor.

At this point  Erin revealed that she had some bad news.  That was the introduction to the first segment of her interview with the CNBC response to Buffett, Julian Robertson.  The key point of her interview seemed to be that "Julian" was expecting a "doozy of a recession."  CNBC viewers got to see this story in repeated segments all day, with reminders of the crash of 1987.  Burnett also interspersed her own reading of the Caterpillar report, emphasizing weakness in non-residential construction.  Others noted that this was an unusual foray for her, so that probably explains the lack of context -- a company that has been conservative in forecasts and aggressive in calling for Fed action.

Does This Matter?

For the "buy and hold" investor, this is all meaningless noise.  Those who watched the Warren Buffett interviews caught his quip that he hopes to live through a couple of more recessions.  He buys good businesses (as do we) and does not worry about economic fluctuation.

Unfortunately, many investors take the wrong cues from information.

Who Knows What?

The average investor (and many rookie hedge-fund mangers) think that someone with the title of "legendary investor" knows everything.  Do you know Julian Robertson's record at recession forecasting?  We do not, so we are not impressed.

The doom-sayers on the economy and the market have a multi-year record going:  all wrong.  One of our best sources of wisdom, Scott Rothbort, compared Garzarelli and Robertson on TheStreet.com's RealMoney Silver site (the really good stuff for those who pay the most.  Worth it for active traders).

CNBC is pitting the bullish Elaine Garzarelli against Julian Robertson. Garzarelli is a bull. Robertson is a bear. While you have to respect both, Robertson peaked in the early 1990s, missed the entire tech boom and made some poor investments in currencies and airlines. Garzarelli's track record since her prediction of calling the crash has been excellent.

When I made my first "Kudlow & Cramer" appearance several years ago, to my surprise and delight, Garzarelli was the other guest. To borrow a phrase from Oprah, "You go, girl!"

Conclusion

This article is not intended as a criticism of Erin Burnett.  She is doing her job, and doing it well.  The question for investors is how to interpret the media imperative.  CNBC seemed to be on a mission:  Their "legendary investor" interview had to be as important as Claman's Buffett interview. 

This is a trap for investors--and an opportunity.  The bearish story is more exciting, more newsworthy, and more understandable.  There is a chance that the Fox Business Network launch will be a race to the most dramatic interviews.  Discussing the fundamentals of interest rates and forward earnings is boring but profitable.