“Years ago I noticed one thing about economics, and that is that economists didn’t get anything right”
Nassim Nicholas Taleb
Markets have a voracious appetite for macroeconomic news and events. Whether it’s GDP, Non-farm payrolls or the latest decision from the Federal Reserve, the market is always waiting for its next hit of macro data
And no wonder, because the market reaction on the day can be powerful. However when the dust settles and we look back at these events we realize they were not nearly as meaningful as we imagined at the time, particularly when the data gets revised beyond recognition.
GDP and Non-Farm payrolls are both measures that are followed very closely by the market. They are also both notorious for the subsequent revisions they are subject to.
According to the Bureau of Economic Analysis, quarterly GDP is revised on average by 1.3% between the first estimate and the final estimate. This means that the latest GDP reading of +3.5% (3Q14) could be close to 5% or it could be as low as 2% when the final numbers come out. Worse, in those situations when GDP is close to zero, we have no idea whether GDP is growing or shrinking.
Furthermore, we should remember that GDP is a poor proxy for the accumulation of wealth (which is what investors should be concerned with). Not all GDP is equal. If the government paid us all to dig up our front yard, this would be recognized as a massive increase in GDP – but there would be very little wealth creation. In fact we would be significantly poorer as we were left with unusable space in front of our houses. This is exactly how communist governments produced the illusion of growth in the economy even while the people on the ground recognized that there was no growth in wealth.
My point is this: If you’re looking for wealth creation opportunities it’s far better to look for it at the level of the individual company, not the level of the overall economy, and certainly not at GDP figures.
Non-Farm Payroll figures are even more of a farce. Go to any Wall Street bank on the first Friday morning of the month, and you’ll find financial professionals reduced to a gaggle of idiots, obsessing over a number that means next to nothing. According to the Bureau for Labor Statistics, monthly non-farm payrolls are adjusted by 56,000 on average between the initial estimate and the final estimate. Sometimes they can be revised by much more. In September 08, the BLS told us initially that the economy lost 159k jobs. The final number was more than twice that at 403k. In the light of such uncertainty you might be wondering why the number has taken on such significance. It is important only because the market deems it to be important, hence we see a self-fulfilling move on the day but very little lasting impact.
The temptation to connect the market to the macro usually proves too much for us. If good macro news drives the market up, we cheer the progress of the recovery. On bad news, we bemoan the lack of vigor in the economy. If the market rises on bad news we declare: “bad news is good news”. So long as we can tie it to the macro we are happy that we understood the situation.
But this is dangerous. In fact most of the big turning points in the history of markets have very little to do with macro news on the day.
The crash in the Dow of 12.8% on October 28, 1929 was accompanied by very little macro news. Robert Shiller in his book “Irrational Exuberance” concludes that “The most significant concrete news stories in the newspapers seem consistently to have been about previous moves of the market itself…There is no way that the events of the stock market crash of 1929 can be considered a response to any real news story”
Again it’s hard to find any macro triggers for the stock market crash on October 19, 1987 (when the Dow fell by 22.6%). Shiller notes: “The crash apparently had nothing particularly to do with any news story other than that of the crash itself, but rather with theories about other investors’ reasons for selling and about their psychology”
In my experience there is little to be gained from a slavish devotion to following macro news. In many cases it can be misleading since the immediate macro data often obscures more fundamental imbalances in the economy. Peter Schiff, the CEO of Euro Pacific Capital, was continuously ridiculed on CNBC through 2006-2007 for warning that the economy was weak. Other commentators pointed to positive macro data and couldn’t understand what he was on about. Of course Schiff was later vindicated in a dramatic way when the credit bubble exploded.
It’s hard to avoid the constant chatter around the latest piece of macro news – we read about it in the press and we naturally enjoy the discussion that surrounds it. Pointing out that the data is flawed or that it obscures a deeper issue makes people feel uncomfortable and is often met with blank stares. But if you want to be a better investor it’s important to look at things differently and spend your time instead understanding the multiple factors that really do matter for your investment.
“If Fed Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn’t change one thing I do”