The Big Picture
“The story the data tells us is often the one we’d like to hear, and we usually make sure that it has a happy ending.” -Nate Silver
Interpreting data to fit a narrative or an agenda! Say it ain’t so…
The Signal and the Noise was written by Nate Silver and discussed “why so many predictions fail, but some don’t.” Obviously, prediction is difficult. Why do we continue to seek out predictions which so often land very far from the actual outcome? This points to human behavioral issues. Most people feel a great sense of comfort in being told what is to come, that all will be well, and there is no reason to worry. Of course we know that will not always be the case. So we must prepare for all scenarios.
If we were to look for signals among the noise that may assist us in recognizing a pending change to an unfavorable market and economic environment; what would they be? What characteristics should we look for in the individuals announcing the signal? Why have we not found this Holy Grail already!? In reality, this endeavor is a bit more complex and most likely unobtainable.
Have a Plan and a Process!
From the Trenches
“Until you remove the noise, you’re going to miss a lot of the signal.” – Seth Godin
Talking Heads: The Fox & The Hedgehog
Philip Tetlock, a professor of psychology and political science, postulated that there are two types of commentators that forecast in the media, foxes and hedgehogs. The traits of a hedgehog are specialized, stubborn, order-seeking, theoretical, ideological, and confident. Whereas the fox is multi-disciplinary, adaptable, self-critical, cautious, and empirical. You can see how traits of both foxes and hedgehogs are not all negative. However, in making a prediction the fox tends to make much more accurate forecasts than the hedgehog. Nevertheless, the hedgehog appears most often in the media, and tends to be more favored!
Why is that?
The hedgehog stands up proudly and confidently and states exactly what is to come. There is no wishy-washy well maybe we see this or maybe we see that. The hedgehog is the exact definition of perceived wisdom: “The gentleman very confidently proclaimed that this is to be so… and he did so on CNBC… so this must be the event to come. I feel good…”
Not so fast.
The fox also appears on mainstream media from time to time. You have seen them, and you likely did not come away with the same feeling of certainty and comfort after the fox spoke. The fox understands that there are simply too many moving pieces to be so confident in a forecast. He or she knows the world is complex. The fox understands that signals can be ambiguous. The fox operates on probability, not certainty. The fox accepts uncertainty.
What about the Noise?
The noise is what I am addressing much more frequently than I would like to admit! I understand why this is so as the noise is what is receiving the most attention. The noise is news-grabbing. Look what just happened in (fill in unstable area of the world here!) Did you hear what the President just said or tweeted (fill in the outrageous comment here!) You get the idea. See my post “Summer of the Shark” from August of 2017. Slowly but surely I hope that most consumers of media are realizing that the sole purpose of the majority of the media is to gain viewers/readers and keep viewer/readers. Anything will be said or done to achieve this! They are purveyors of noise.
“The Hot Take” – an unending stream of contrarian opinions expressed in the most incendiary way possible, solely for the entertainment value of contrarian opinions expressed in the most incendiary way possible!” Special thanks to Dr. Ben Hunt for that. Hedgehogs are very good at this!
Bottom line: Forecasting is not easy! We are attempting to predict the future after all. Most of what you are hearing is noise simply intended to keep you tuned-in for more noise! The real signal is often missed entirely or explained away (i.e. this time it’s different!).
The Weeds
“There’s no silver bullet, we have to change as we go.” – Tom Leighton
For those familiar with me you likely already know where I am going with this. Apologies if there was an expectation of the silver bullet! We simply cannot position for today with the expectation that nothing will change tomorrow that may effect our original position. We also cannot expect that the same signals that led to negative outcomes in the past will repeat in the same manner. However, they often rhyme! This is referred to as fighting the last battle. Wars are lost with this thinking.
There is no Silver Bullet.
Unfortunately no one signal can provide us with certainty of an economic or market downturn. There are however aggregate factors that support particular market environments as well as factors that do not. The aggregate is important because it is usually not a sole factor, but many in unison. What I mean by this is we find the same general traits present during growth environments as well as the same general traits present during contracting environments. It is critical to be monitoring these traits on an ongoing basis! The story is ever-changing and evolving with new data.
For example, during growing economies we are looking at several factors: employment data such as wage growth, stable earnings of companies, moderate inflation data, new investment, etc. The list goes on. Notice I said stable earnings. Why wouldn’t I just say very high earnings?! High or fluctuating earnings may be a red flag. A high earning company (i.e. high profit margins) may attract new competitors and cause the price of said stock to go down. Or what about a technology company not spending those margins on research and development Technology requires ongoing innovation. Lastly, economic makeup is also important. The U.S. is primarily a consumption and service economy. However, other countries are primarily export economies. This is why many people do not enjoy the study of economics! It is not overly complex, but not so simple either.
This post is part one of…? This is a substantial subject and there is much to discuss! In part two I will elaborate on how through process we monitor big picture signals as well as small picture signals. And what signals lie in between.
Bottom Line: Economics is more complex only due to a multitude of data points that must be monitored. We are receiving signals nearly everyday. The media makes a living on amplifying every signal to a momentous affair! However, it is never just one signal, but an aggregate of signals that matter.