Although the title might appear to be random at first glance, I promise that there is an underlying theme. This article is the first in a three-part series that will discuss how individual investors are bombarded with information about what happens in the financial market. Most of the time you might hear that, 5 out of the last 7 times “x” happened, the S&P 500 index went up by 10% or more. I will argue that most of these types of comments might be useful trivia for the television show, Jeopardy; however, they should not impact your long-term investment plan.
So, why did I use breakthrough drugs? Prior to any drug coming to the marketplace, the FDA does a very thorough review of the test results to ensure that the drug is safe and also its efficacy is not overstated. What if I told you that a pharmaceutical firm came up with a possible cure for lung cancer, and there were successful trials of 10 individuals. Does that sound like a group too small to draw any conclusions? Would you take a drug that the testing was only done on a handful of people? Now the FDA would never allow such a thing, and there are tons of protocols and blind or double-blind randomized testing of many individuals. It just sounds weird if only 10 people were tested, and there was also no control group (i.e. a separate group given a placebo).
While the drug example seems a bit outrageous and contrived, I bet you can think of similar examples in the daily financial press (e.g. financial television or print media). Whenever you hear a small number of events happening that “tend to” lead to certain financial market outcomes, you should be extremely wary. For instance, I just heard today that, after the Singles Day huge ecommerce sale by Alibaba, the stock (Ticker Symbol: BABA) is up 80% of the time over the course of the next two weeks. Well, when did Alibaba start Singles Day? The first Singles Day sale was in 2009. Therefore, we have 10 data points to work with (2009 to 2018). Given the information I referred to above, the comment made today simply says that the stock has been up after two weeks 8 out of the last 10 years. Now I will try to hold in my red flags and bit of ludicrous thoughts, this type of information is not informative at all. There are just too few observations to draw any sort of valid conclusion.
Here is the plan of attack for the next two articles. The second part of this discussion will focus on statistics. Yes, I know this topic is not too much fun and can get complicated very quickly. However, individual investors need to know a bit about statistics to recognize when a quantitative quote is totally useless. We will not get too granular though, I promise. Essentially most financial market data is time series data. Different rules apply in that case, and these rules are broken all the time by even the most sophisticated professional investors and commentators. The third part of this discussion will be an in-depth examination of an actual event that grounds my argument in recent events. I will examine what is called the inversion of the yield curve and how it normally portends a recession for the U.S. economy. Don’t worry; I am going to explain those terms when the third part of this series rolls around.
Please join me in a critical review of all the financial market and economic data you get bombarded with. So much of it is just “noise” or simply interesting trivia at best. Note that the interesting trivia cannot guide or inform your particular asset allocation of investments. As always, if you have questions along the way, please feel free to comment on this or any other article.