Great Investors Know How to Interpret Data

I am working on the Eight Traits of the Insightful Investor.

These are skills that regular readers of "A Dash" will already know as part of their routine. New readers can enjoy the show, and everyone is invited to join in the comments. Please let me know if you disagree with one of my examples or even if you have a different slant. I am also very interested suggestions for future posts.

Background

I have struggled a bit with getting this theme started. The basic reason is that I really want to be positive.

1. I embrace the openness of the Internet tradition. I encourage other writers, and we all learn from free exchange;
2. Information comes from many sources. I have cited cab drivers in the past. Eclectic is a motto for me; but
3. Credentials matter. The flow of information is a fire hose. The investor really does need to distinguish between those who know something and the pretenders.

Interpreting Data

The average investor has been encouraged – mostly from the TV commercials from online brokerages which collect your commissions – that you can make a fortune by trading. You only need to learn a few simple rules, consult with their (rookie) phone helpers, look at some charts, set trading rules, and you are on your way to riches.

This is very wrong, but the error is challenging to explain. I cannot show the skills without also illustrating the blunders. In this series I will give the links to the sources (all prominently republished or I would not have noticed), but the identities are not the important feature. I am trying to teach the skill of critical thinking as applied to data. Those who disagree with a particular example may sound off in the comments. If someone objects to being cited, I welcome a rebuttal. I do not expect to get any!

Today's Test

See what you make of this chart.

The author correctly uses a log scale so that we can interpret growth in percentage terms. This is much, much better than many pundits who deceive you by making normal growth look like a hockey stick.

The author interprets the chart as follows:

"My analysis shows we are experiencing rapid inflation right now; but the way the government calculates its numbers masks the true story of inflation.

To understand what's at stake, we need to go back to Economics 101.

What we are now seeing in the U.S. economy is monetary inflation. This happens when the money supply increases. The increase in money supply eventually causes currency devaluation, which results in higher prices for goods and services as buying power declines—this is classic inflation. (Throughout history, monetary inflation has eventually become price inflation.)

Consider the chart of the M2 Money Supply reproduced below. M2 is considered to be a broader measure of the money supply—it includes savings accounts, deposits, and non-institutional money market funds, in addition to the currency already in circulation."

The entire article is aimed at scaring retirement investors, and it was given extra reach through republication.

The Reality

If you really took Econ 101 you would probably understand that a larger economy requires a larger money supply. Try improving the chart in two ways:

1. Let us suppose that you extended the time period. That would tell you if there was some recent alarming trend.
2. Let us further suppose that you added GDP for a comparison. That would show whether money supply was disproportionate.

Here is what you would see:

There is nothing unusual about current M2 growth. It is a normal rate and it is also in line with GDP. If anything, the growth in the money supply lagged a bit in the post-recession period, the reason for the Fed's QE programs.

Conclusion

The entire post is much ado about nothing. The author is selling a scary story. I know not whether it is gooseschmitz or wolfschmitz. In either case, investors should not be buying this tall tale.

The Insightful Investor needs to learn what to read. When you spot bogus analysis like this, you might economize by skipping that source in the future. Maybe you could put the author on warning with a comment.

I have many other items for this series and I welcome comments and suggestions.

Comments

[J Kloss]

Thanks for this analysis Jeff.

My educational and working background are in physical sciences and software. After semi-retiring, I'm now studying economics and finance diligently. Your analysis methods are rigorous which I appreciate. Unfortunately, I would not have known to compare GDP to M2 nor would I feel comfortable with my layman's interpretation of correlation vs. causation.

The good news is that a less precise method ...taking a quick look at the site referenced... would have, unscientifically, led me to ignore the writer anyway. Here are a few clues supporting my knee-jerk but appropriate reaction:

* The site's favicon is a $

* The site's text is peppered with the word "gold". While I am gold neutral, it is obvious to me the site's author is probably not.

* Prominently displayed are phrases boldly claiming "A golden opportunity" / "Profit Confidential" / "Special Report" / "Hot Off The Press" / "A Dire Warning" / "Guaranteed Oil Pension Checks" etc.

* If this site were a physical place of business, it would likely have a doorman swinging the door wide and screaming "Today only! Come take a look! We have it all! Don't let this opportunity pass you by!" as potential clients walked passed.

In my experience there are few, if any, sites having that look-n-feel which are legitimate or contain information I would trust. This is a real-world skill many of us hopefully brought to the virtual one. Sites like "A Dash of Insight", "Calculated Risk", "The Big Picture" et. al. pass the "Is this a serious site?" whiff test. "Profit Confidential" does not.

Bottom line: Looks count.

[Ed Foster]

This is another great post. These types of misleading charts pop up with some regularity.

I'd like to remind you of your Nov. 7, 2012, post regarding the 100% Recession Chart. This thing suddenly appeared all over the Internet. Numerous commentators used it to predict an imminent recession. Of course, they didn't check with the authors of the chart.

You did check, and debunked their arguments. On Nov. 7, the S&P 500 closed at 1394.53. As of the close on 8/30/13, the S&P 500 was up 238 points, or 17 percent. Some recession!

Your Nov. 7 post is at http://oldprof.typepad.com/a_dash_of_insight/2012/11/debunking-the-100-recession-chart.html

I hope you will continue to write these posts. The charlatans' work, if unchallenged, can be dangerous.

[Brian]

Thank you! This is a great series. If people stopped to actually think about what they read we would be much better off. Critical thinking takes practice, and knowing what to look for. Unsophisticated investors can get easily snookered when they are presented with exotic charts talking about the money supply, QE, etc.

[babak]

What do you think about purely technical interpretation of data without fundamentals and using sound management ?