Reviewing Economic Data

One of the benefits of writing a blog is the feedback from readers.  Here at “A Dash” we certainly do not have a “boo-yah” society.  Readers feel free to swing freely and offer arguments and links.  Great!  And thanks!

Sometimes we write an article with a mission related to our book, one geared to individual investors and including a chapter on Internet traps.  Yesterday we tried a somewhat whimsical approach and it seems like we missed the mark.  It is often difficult in print.  Sports Illustrated, in April, 1985, wrote about a rookie pitcher, Sidd Finch.  This was quite a find for the Mets, since he had a 168 MPH fastball.  Many readers did not understand the April Fool’s joke.

And this was a fairly obvious situation, not like what we do in blogs.

There are only so many ways to escape from a pedantic mode.  Since we do not embrace the colorful language of other sites, we occasionally try for humor in other ways, hoping that some appreciate.

Revisiting Economic Data

Taking the cue from our excellent reader comments, let us merely state a few observations, as follows:

  • Intelligent people can look at the same data and reach different conclusions.  If you think that yesterday’s data had a clear-cut message, you missed the point.  Take a step back and look again.
  • Those with a mission use inconsistent rules for interpreting data.  Do we really care about revisions to data from eight months ago?  Market pundits on a mission usually dismiss such information.  It is relevant only to the academic and historical question of when the recession began.
  • Those with a mission pick the adjustment that fits the viewpoint.  Sometimes it is inventories, which can be viewed in different ways.  Astute businesses build up inventories in anticipation of sales.  Or inventory build-up can be involuntary.  It is subject to spin.  That was the point.
  • New and creative methods. This is the realm of inflation adjustments.  Those who prefer to reject the official data have dredged up (yet another) method of objecting.  There are various methods of adjusting price changes, each geared to the particular economic problem.  The recessionistas did not get the negative GDP number they wanted, so they object to the methodology.

Just think about this.  Would it not be nice for those debating the economic issues to agree on the measures — in advance, before they come out.  Instead, we find data that supports a particular viewpoint is readily endorsed, while any contradictory information gets the hatchet job.

Our Take

Please note that none of the above reflects any argument that we have a strong economy or some perma-bull philosophy.  Regular readers of “A Dash” know that we have been quite flexible in our approach to the market.

Having said this, we try to warn the average investor about those who are determined to find the worst in any economic report, especially those pundits who have done so for many consecutive years. 

Temptation and Greed: Lessons from Sports

Last year we reviewed Dr. Brett Steenbarger's Enhancing Trading Performance, one of our recommended readings.  We made the observation that the book should be read by competitors in all fields, not just trading.

It works both ways.  Many of the lessons from sports can be applied to trading.

Playing within Yourself

Athletes often mention the idea of playing within yourself.  It means not over-swinging at golf, as Harry Vardon, for whom the PGA scoring average trophy is named, always did.  Golfers and traders should both check out the quotation on Jon Leland's excellent golf blog.

Harold Reynolds, a great base-stealer and fielder, writes about how he learned to play effectively.  He looked at the giants of the game at his position, second base, and came to the following conclusion:

When I was able to reduce them from the giants they were in my head, to
the same size of the man I saw in the mirror, the vision came alive.
They all had a special skill that stood out amongst the group, but once
I set that skill aside, it cleared my vision and I realized not only
were we similar in physical stature, but we basically all had a similar
style of play — catch the ball, hit for good average and don't make
mistakes. After assessing the competition, I concluded that if I could
play within myself, which meant catching the ball, putting it in play
and stealing bases, why couldn't I be an All-Star too?

We could find examples from other sports as well.

Why Players "Reach"

Frustration and lack of success are driving forces.  Players who are striving to recover make unsound decisions.

Poker Superstar Daniel Negreanu cites this important lesson:

Bad decisions are born from a lack of focus combined with a lack of
confidence. In order to be at your best, you have to separate the past
from the present, and devote 100 percent of your attention to the here
and now.

Bringing this back to trading, Dr. Brett's blog has an excellent series on frustration and trading.  The following quotation is from the first part, but readers will benefit from reviewing all three parts.

When a trader emotionally accepts losing as part of the business, loss is not so threatening.
With proper money management, it can be contained and need not pose
more than an annoyance. But if a trader *needs* to make money–perhaps
because of perfectionism, or perhaps because of dire financial
circumstance–then normal loss might be experienced as unusual
frustration. It's the overriding *need* to make money that sets the
trader up for acute frustration.

The Result?  A Typical Investor Mistake

David Merkel has a first-rate analysis of an investment scam.  He takes a stock that is a likely pump-and-dump candidate and carefully shows how an investor can be taken in by touts.  Every individual investor should read this article carefully and be prepared to ask similar questions.

The only thing we might add to David's article is a comment about "why".  We know that these schemes work, if only because companies are paid to circulate this "research."  People listen because they are trying to hit home runs or drive the ball 300 yards.

The Investor Lesson

Our own education on this subject came about ten years ago.  One of our most valued investors asked us to design a program to complement our sector rotation strategy.  This caused us to review our methods and record over the prior ten years.  While we had done well, there was a major opportunity for improvement.  We discovered these two key things:

  • Many clients wanted instant winners and home runs.  We obliged with our best shots.  These speculative plays, as one might expect, had highly variable results with some big losses.
  • The "basic strategy" of finding strong themes and more modest valuation advantages actually performed better, and with much less risk.

The request from the investor led to the development of our most successful program.  An important element is the definition of the goal — a double in three years.  This is a compound growth rate of 24%.  It is an aggressive target, but not the stuff of the heady 1999-2000 era.

Do we achieve the target?  Of course not, but we get nearly half of it.  Reaching for more actually generates a lower return.  It is an important lesson.

Investors swinging for the fences should expect plenty of strikeouts!

Reviewing Three Characteristic Business Decisions

Successful trading and investing requires finding an edge. At "A Dash" we look for broad themes that most are getting wrong. Since there are many very intelligent, very savvy people who work in the investment world, it may be difficult to find corners of knowledge that are under-represented.

We have suggested that one such opportunity is the very poor understanding of government and the policy-making process. Few seem to remember their role, be it analyst, fund manager, or investor. Instead they react as a voter, using their personal opinions about the merits of the policy.

Take our recent discussion of housing problems as an example. For many observers it is important for them to express their personal feelings about the merits of the legislation — whether it will be effective, whether it is fair to those not affected, how much it will cost, and the possible message to future borrowers and businesses.

These are all excellent questions, if one is a Member of Congress deciding how to vote on the bill. They have little or nothing to do with the impact of the legislation on the housing market, the economy, or the stock market.

The Business Comparison

We know from many years of teaching and interaction with investors that most people have a strong personal bias. In a broad sense, they believe that government is error prone and dysfunctional while business is efficient and effective. In fact, the decision-making processes of large organizations in the public and private sector are quite similar. The classes in MBA and MPA programs are more similar than different.

We are going to take a harder look at this bias, starting with a better understanding of organizational decision making. Readers who spend a few minutes with us on this summary will be getting the most relevant portions of classes ordinarily requiring many months of study.

Revisiting the Business Examples

Some time ago we provided three examples of business decisions. These were all actual case studies of widely-known businesses in actual situations. To appreciate fully our point, please take a few minutes to review the prior article. Make your own guess about the situations involved. The actual companies are identified at the end of this article.

Decision-Making Types

Organizational decision making can be usefully classified as one of
three quite different types. While there is an extensive literature in organization theory on this problem, our analysis is chiefly inspired by one work, Essence of Decision: Explaining the Cuban Missile Crisis, by Graham Allison (now added to our recommended reading list). The Wikipedia article notes the seminal nature of this work, which they identify as the "founding study of the John F. Kennedy School of Government.

Allison identifies three models–the rational, the incremental, and the bureaucratic.

In the
“rational” model, the organization analyzes problems and creates general
solutions. Decisions resulting from the rational model are often similar to
those of a single human actor. This does
not mean that the decisions are the most effective, just that they exhibit a
certain consistency of method and planning.

Some organizational decisions are more like piecemeal reactions than
general solutions. Decisions may be
reached to try a number of simultaneous approaches not all of which are
consistent. This method, which can be
called the incremental approach, results in policies that address part of a
problem. Ideas that work get
expanded. Those that do not often die

A third broad type of decision making is bureaucratic in
nature. Any large organization – private
or public – has different departments or parts. Each department has its own interest in control over a project, expanded responsibility for members, and veto of anything that does not fit. It is highly rule-based.

Returning to the Three Business Decisions

The first example, Company A, was The Coca-Cola Company (KO). After taste-testing comparisons, they abandoned the original recipe for their leading beverage and launched New Coke. The failure of this initiative led to some fast footwork, including the resumption of Classic Coke.

The second example, Company B, is Google, Inc. (GOOG). Google innovates by encouraging employees to develop ideas, allowing everyone time for that brainstorming function. The myriad of Google search applications is a result of this approach. Some, like Google Maps, get expanded. Others, like Google Answers, may end after testing. It is a modern success story illustrating the incremental method.

The third example, Company C, is a major auto company that we will not name here. The company considered a plan almost identical to the current initiative by Chrysler. The Chrysler plan, well-known to anyone seeing their current advertising, has successfully drawn new customers to the showrooms by offering fuel price protection to the average buyer. Chrysler realizes that there is a need for a transition to more fuel-efficient vehicles. The price protection approach helps them to succeed in making that transition. Chrysler was able, through a new leadership team, to overcome entrenched departmental bureaucracy.

Application to Public Policy

The takeaway for investors is realizing when government agencies are following a successful process. Too often the market pundits will criticize a policy as being too small and not comprehensive. Recent examples include the various Fed initiatives to address liquidity in credit markets and the assortment of actions directed at the housing market.

We will review each of these decision processes in more detail. For now, investors can gain by taking a more open-minded approach to government actions that do not seem, at first glance, to go far enough.

A preview: Most pundits make the initial student mistake of thinking of government strictly through the rational model.

Economics IQ Answers

Last week we presented a small true/false quiz with a number of economics statements.  Some of the statements are true, but possibly misleading.  The quiz is repeated below with answers following each question.

The Quiz

  1. Home prices are now deflating at a 32% annual rate, versus 8% six months ago.  [True, but misleading.  You get this result by taking the rate for a single month and multiplying by 12.  Taking two specific points like this is often misleading.  Why not the rate last month? Or a year ago?
  2. Inflation, as measured by the CPI, shows housing costs to be increasing according to the "imputed rent" formula. [True.  Despite the decline in housing prices, the impact of housing on the CPI is +2.6% year over year for about 24% of the consumer basket.]
  3. Planned corporate layoffs rose 68% in April to a total of over 90,000. [True]
  4. As long as the largest asset on household — and bank — balance
    sheets continues to deflate, the credit and consumption hits will keep
    coming.  [Marginally true, but aggressively stated.  See #10]
  5. The US economy created about 2.5 million new non-farm payroll jobs last month.  [True, but potentially misleading unless one understands that about 2.5 million jobs are also lost each month.  The point is to show the dynamic nature of employment changes.
  6. The TED spread is now at 86 bp's, down from 204 in mid-March. [True]
  7. The Baltic Dry Freight Index has plummeted, showing global economic weakness. [False.  It is back to the former highs.]
  8. The Fed has devoted about half of its balance sheet to "unusual" liquidity efforts. [True, although many believe that the "balance sheet" approach does not reflect a real limitation on Fed power.]
  9. The BLS Birth/Death adjustment has reduced past predictive
    performance, as measured by actual state employment counts when the
    data became available (months later). [False.  The Birth/Death adjustment has improved results throughout its history.]
  10. Household liquid assets at $21.9 T and net worth at $31 T are about
    1% below the all-time records as of the most recent published data. [True.]

The best scores among those who submitted answers had eight correct answers.  We realize that some may disagree with the interpretation on a couple of the questions, but each raises a point of some interest.

TCA-ETF Update

Jeff is on the road again.  Below is the weekly TCA-ETF Update.  He will comment more if he gets the chance.



TCA-ETF Update

Jeff is on the road, so I will provide the weekly update.  Jeff will comment more upon his return.

~ Renae

UPDATE:  An advantage of having a good team is that one can travel and take vacations without worry that the strategy is implemented properly.  Like anyone managing investments, we realize that there is never a pure day of vacation.  Being in touch is now possible wherever one is, especially with someone watching to give updates.  Writing on "A Dash" is lower in our priorities than making decisions, as it should be.  For the moment, we are trying to do to things:

  1. Our original concept — letting readers who are interested in evaluating ETF’s have a peek at Vince Castelli’s innovative approach.  It is our belief that many might find this useful, especially if they read our report (available free upon request) on how the model worked over an interesting five-year period.  This is not specific investor advice, but it is a factor that ETF investors might wish to consider.
  2. A specific interest on the part of some who are tracking the model.  We strongly believe that the best way to evaluate a system is by looking at the process and by reviewing long-term, carefully-constructed tests.  Having said this, many choose to make decisions on real-term developments.

To make it easier to interpret current results, we look at what we call a "cycle."  A Cycle starts when we are completely out of the market and ends when we have made another complete exit.  The current cycle is down 2.9%  For comparison, the S&P 500 is down 2.3% and the NASDAQ is down 5.2% over the same period, as of Wednesday’s close.


Is the Fed Ahead of the Curve?

The overwhelming sentiment of popular market pundits is that the Fed is out of touch and "behind the curve."  (One of our hopes for 2008 is that writers will find some other phrases to describe this tired sentiment).

Other Expert Views

Fed policy has an effect with a lag.  One way of examining this is to compare Fed action now with policy in past possible recession situations.  This method is not used by those pundits whose overconfident view of the future leads them to data supporting what they already see as inevitable.

An interesting contrast is to look at observers who do make this comparison.  Two of the very best in recent years have been Dick Green, the CEO of, and David Malpass, Chief Global Economist for Bear Stearns.  At "A Dash" we have frequently cited their comments.

Dick Green of has a consistent and sensible approach, that has demonstrated accuracy over several years.  He writes as follows:

Enough data is now in to state conclusively: fourth quarter GDP will post a
solid gain.  That means the Bernanke Fed began cutting interest rates well ahead
of significant economic weakness.  Their early action will help prevent

Green goes on to explain the basic rationale (but follow the link to read the entire article):

The Bernanke Fed has therefore cut the fed funds rate target from 5.25% to
4.25% even as real GDP growth was up at a 5% annual rate in the third quarter
and a 2% annual rate in the fourth quarter.

Furthermore, the Bernanke Fed has taken strong efforts to provide liquidity
to the banking system to address the problems in the credit markets.  This is
now starting to pay off.  Credit growth has continued, as evidenced in the weekly H.8 data,
and now the prices of mortgage-backed securities appear to be stabilizing, as
reflected in the ABX
derivatives contracts

David Malpass has a similar view, with similar reasoning.  Malpass still sees slowing growth, but rejects the notion of a housing-led recession.  His recession odds have been lowered to 20% (which is actually the long-term average for a given year).  Malpass wrote on December 21st (you need to be a customer to get this) as follows:

We think the Fed has been unusually proactive – it is now probably at or close to the end of its rate cuts, and will try to use other confidence-building techniques going forward. We think an expression of interest in a stronger dollar would be the most useful, but is unlikely.

This shows his view of the economy, but those wanting more rate cuts will find it discouraging.  Malpass explains his reasoning:

We think the Fed has been distinctly more proactive than in past slowdowns. The Fed maintained high interest rates until the brink of recession in 2001 (Fed funds at 6.5% in early January 2001 with recession starting in March 2001) and into the recession in 1990 (Fed funds steady at 8% through October 1990, even though the recession started in August.)

The Fed acted earlier this time, and is also using innovative methods like the TAF auctions.

Many bears highlighted Malpass when he became more pessimistic earlier this year.  Doug Kass, for example, called Malpass a "must-read."  We are waiting to see what Doug and others say about Malpass’s latest perspective.

Our Take

The assessment of recession prospects and the Fed reaction has been one-sided.  Whether one reads the mainstream media, blogs, or watches financial television, the popular comment is that the Fed has not acted quickly enough. (If only we could collect royalties on "behind the curve.")

At "A Dash" we have tried to emphasize that the Fed is attempting some creative tools in addition to cutting interest rates.  Meanwhile, those who have long-standing recession predictions appear to be wrong once again this quarter.

There should be a statute of limitations on these forecasts.  The key question for the investor and trader alike remains how much of the "baked in" earnings discount from a recession will actually occur.


Do You Think You Are Pretty Smart? Part I

A number of my trading friends were laughing about the results from  a recent survey of the American people.  They were good at naming The Three Stooges, but did not know basic facts about government.

I posed this very reasonable question:  Who is the second most powerful person in government?

If you are thinking it might be Ben Bernanke, your focus is too narrow.  There is more to government than the economy and the stock market.

The power may well reside with the person closest to the President — one who makes many of the actual decisions and has tremendous influence over who gets access to the Oval Office.  Without access, the President will never hear your story.

Still guessing?  If you ever watched The West Wing, you should know that the Chief of Staff has developed into the most important position.

If you realize the significance of the job, then you might want to know who has this power.  My guess is that fewer than 5% of Americans would recognize the name Joshua Bolten.  More might know Andrew Card because he held the position for 5 1/2 years, an all-time record in this stressful job.

Some think that the Chief of Staff is not as important in the Bush White House because of his ties to cabinet members.  It is difficult for outsiders to judge the power, but Bolten has already earned credit for helping to bring on board key additions to the Bush team, including Hank Paulson.

By the way, the better-known Karl Rove is a Deputy Chief of Staff.

Recession Odds

Market watchers are all interested in the odds of a recession.  You will not get an accurate view from stories making a big splash.  Since an economist is unlikely to be newsworthy by predicting a 10% chance, it is not surprising that Barry Ritholtz’s citations of recession odds predictions ranges from 30% to 70%.  (Roubini is getting a lot of publicity for his extreme viewpoint.)  Unless a reader of these stories has also read the Wall Street Journal economist poll, the impression will be misleading.

Enjoy Barry’s links (and thanks to him for the work even while in Denver).  Then take a look at our comments on the WSJ recession odds.

Link: Rocky Mountain Linkfest!.

Another week, another collection of mayhem: From the Fed pause to the not-so-friendly skys, indices lost between 1-1.5% this week, as investors digested lots of news this week. Surprisingly, the airports were not nearly as problematic as you might have …

Continue reading…

Recession Odds

Market watchers are all interested in the odds of a recession.  You will not get an accurate view from stories making a big splash.  Since an economist is unlikely to be newsworthy by predicting a 10% chance, it is not surprising that Barry Ritholtz’s citations of recession odds predictions ranges from 30% to 70%.  (Roubini is getting a lot of publicity for his extreme viewpoint.)  Unless a reader of these stories has also read the Wall Street Journal economist poll, the impression will be misleading.

Enjoy Barry’s links (and thanks to him for the work even while in Denver).  Then take a look at our comments on the WSJ recession odds.

Link: Rocky Mountain Linkfest!.

Another week, another collection of mayhem: From the Fed pause to the not-so-friendly skys, indices lost between 1-1.5% this week, as investors digested lots of news this week. Surprisingly, the airports were not nearly as problematic as you might have …

Continue reading…