Hedge Fund Managers and Data

In market-based activities, the errors of others present opportunities.  It is profitable to look for any aspect of analysis where many are getting it wrong.  Since hedge funds are such an important part of the current market, understanding their managers is also essential.

Understanding and interpreting government data is fertile ground.  It is especially good for me, because of my background as a former poli sci prof, government consultant, specialist in research methods, and long-time consumer of government information.

Contrast this with the average hedge fund manager.  Now don’t get me wrong.  These managers are among my best friends!  They are really smart and very talented, or they would never get a chance to run money.  Every last one of them talks a good game and has had meaningful success somewhere.

The problem is that it is a young man’s game.  (I could try to be politically correct, but it is a world of mostly men, and that is part of the point).  There is rapid burnout.  From the perspective of regular business people, the managers are limited in experience.  There is a danger in knowledge that is a mile wide and an inch deep, where you must have an opinion on everything.

We know a lot about what hedge fund managers think because they network, some of them blog, and others write columns online.  They generally want to be contrarian, fast thinking and acting, and willing to make bold moves.  A lot of confidence and machismo is de rigeur.

The idea of being contrarian is quite sound.  It is at the heart of exploiting market inefficiencies.  The irony is how to be a contrarian when all of the other managers are doing the same thing.

Disparaging government data becomes a way of showing off.  Acting like there is a conspiracy to manipulate results may seem like sophistication.  It is usually easy to find some argument and take it to the lowest common denominator.  It is very convenient to dismiss data, since it then becomes possible to argue anecdotally.  If you do not understand something, just dismiss it as irrelevant!

A hedge fund manager who really wanted to be contrarian would want to learn more about government data releases and how to interpret them.  This is the place.

The CPI as a measurement of inflation is such an easy target for pundits.  Let’s start there, but we’ll eventually look at nearly all of the government releases.

No Inflation???

Pundits on TV and websites express amazement that today’s CPI data show no change overall and only a .1% increase in the core rate.  Writers on Cramer’s site, experts on CNBC, and even Bill Gross all claim that government measures of inflation are silly and inaccurate.  To them, it is obvious that prices are much higher than reported.  Just look at medical care, gas prices, hamburger, or home prices.

That argument sure sounds good.  It is easy to understand, and most people do not think it through any more.  That means that for those willing to get a deeper understanding, there is real opportunity.

Let’s look at some evidence and then try to approach the problem with an open mind.

There are several government indicators of inflation, including the CPI, the PPI, the PCE (focused on wage related costs) and the GDP price deflator.  Greenspan favors the PCE, but the others all get some attention and each is a slightly different measure.  They all show inflation as running about 2 – 2.5%  This is not a bad reading.  It is consistent with a healthy economy.

Another way of looking at this is by turning to the market.  The Treasury now issues inflation-protected bonds.  You can look at the difference between the rate for TIPS and the rate for other government bonds and find the expected inflation.

The result is similar to the inflation readings for the next ten years.  This shows the verdict of one of the largest and most liquid markets — hardly the picture of stagflation that some expect.

So what is wrong with the anecdotal story?  Part II of this series will be the explanation.