Economics: The Debate Club

“Think like an investor and not like an economist or politician.” – Richard Bernstein

According to the National Bureau of Economic Research (NBER), since 1857, the U.S. has experienced 33 recessions that lasted an average of 17 months.

That means that there’s been a recession in one out of every five years, on average.

In the post WWII era, we’ve seen 11 recessions lasting an average of about 11 months.

So what can you do with this information? Not much.

I’ve learned that following economic data is something that’s intellectually stimulating but doesn’t really offer much help in the investing arena (which is probably why most economists invest in index funds…a wise choice).

Anyone that’s paid attention since 2009 should be able to understand this dynamic as we’ve seen stocks take off while the economy has been in the midst of a painfully slow recovery.

There is so much economic data and noise out there that it’s very difficult to get a handle on everything.

The government produces data on 45,000 (!) economic indicators each year. And much of this information get revised and adjusted many times before it’s finalized.

Many investors claim the stock market discounts future economic moves by front-running recessions and recoveries.  This can happen, but the stock market and the economy are two completely different animals and very rarely are they in sync with one another.

Either way, it doesn’t make it any easier for economists to predict recessions.

In The Signal and the Noise, Nate Silver shares some interesting data on the predictive abilities of a large group of well-known economists from the Survey of Professional Forecasters (an ironic title if there ever was one).

Going into 2008, the average prediction for GDP growth was 2.4%, just a tad below the long-term trend. GDP actually shrank by 3.3%.

The financial crisis was missed by nearly everyone so we can give them a pass on actually predicting the recession. But, the forecasters were also asked to place probabilities on outlier events.

They assigned only a 3% chance of the economy shrinking by any margin in 2008, let alone a contraction of greater than 3%. And they placed only a 1-in-500 chance of the economy shrinking by at least 2%.

Since 1990, there have been 60 recessions in the various countries around the globe. Economists have forecasted only 2 of the 60 a year in advance.

I actually studied economics in college. It was my major until I realized I wanted to go another route that wasn’t quite so academic.

I switched to business, but I did end up getting a minor in econ and learned plenty about macro and micro economics. These are my biggest takeaways on economics looking back on those studies and what I’ve learned since:

1. Most econ professors are more interested in getting published than teaching. I had one really great econ professor, but the rest seemed much more interested in their research than getting the students to understand economics.

2. Economic textbook learning takes place in a vacuum. Supply & demand, game theory and the expenditure method of calculating GDP are all interesting but most economic theory tends to hold up better on paper than in practice.  Economists work in a world of equilibriums that occur only in models, not real life.  Economics is more of an art than a science that doesn’t account for irrational human behavior.

3. Most economic policy is fraught will political biases. Many economics pick a side in the political arena and generate their theories based on that ideology. This can lead to extremely biased thinking.  The same is true of investors that make their decisions based on political leanings.

4. There are no winners in economics. In financial markets you know if you made the right decision based on the fact that you made or lost money on your investment within your stated time horizon. It’s harder to take credit for economic policies since economists can always claim ‘We should have used more of my theories and it would have been better’ or ‘If we didn’t implement this policy it would have been worse.’ It’s easier to speak in counterfactuals and point out problems than coming up with actual solutions.  No one knows because we can’t look into those bizarro worlds of not making the original decisions.  This leads to constant bickering and debating of what-ifs.

5. TANSTAAFL (there ain’t no such thing as a free lunch) is the biggest crossover lesson I took from economics to the financial markets. There are always opportunity costs from our actions.

6. Trends matter more than specific data points. With almost 50,000 data points, there’s going to be economic indicators flying at you on a daily basis. A snapshot in time does you absolutely no good. What matters most is how things look on a relative basis. Are things getting better or worse? Most economic data is useless to you as an investor.

7. Much like investors are always making their playbook based on the latest financial crisis, so too are economists trying to predict when the next recession will hit. They develop models that would have caught the last recession but don’t hold predictive power for future cycles.  The recency bias is strong as it is in all forms of forecasting.

8. Recessions are part of the deal.  Business cycles expand and contract.  Don’t let them make you nervous because slowdowns do happen when the economy overheats. Recessions are actually healthy as some of the greatest businesses and new industries of our time have been formed in the ashes of their wake.  One study showed that over half of all Fortune 500 companies were started during a recession.

There are times when I wade into the pool of current economic thinking to try to understand the topics of the day. And there are a few economic thinkers out there that are able to simplify their message (this is a skill many intelligent people don’t have) so a wider audience can understand, but the list is short.

Much like politics, the economy is an interesting topic to debate, but one that doesn’t have much bearing on your life on a day to day basis.  Even when it does affect your personal situation, it’s out of your control anyways.

Remember, interesting doesn’t always equate into actionable.

My biggest takeaway from following the economy is that I don’t have to have an opinion on everything. Following too many experts or too much information can lead to cluttered decisions that don’t have an impact on my life in the first place.

The Signal and the Noise

Further Reading:
Stocks and the Economy
What You Don’t Know About Stocks & The Unemployment Rate

Not onto my favorite reads of the week:

  • 10 easy money tips to improve your finances (Blackrock)
  • Why index funds are the next star mutual fund manager (WSJ)
  • How to think about the role of luck in your life (Value Plays)
  • Stock losses increase hospital visits (Forbes)
  • 400 days and counting without a 10% correction (Big Picture)
  • The 8 Mile MBA from Eminem (Altucher Confidential)
  • To defeat my enemy, I must become him (Reformed Broker)
  • Another great Dough Roller podcast, this one with Larry Swedroe (Dough Roller)
  • How to get rich, feel rich and stay rich (Motley Fool)
  • Time to buy the dip in Emerging Markets? (Yahoo! Finance)
  • What will trigger the next correction? (Above the Market)
  • The difference between being good & being bad with money.  Steven Tyler spent $5-6 million on cocaine in the 70s & 80s  so that would constitute being bad with money (Raptitude)