investment porn exposed

[larryswedroe]

http://www.cbsnews.com/8301-505123_162-57378516/will-investors-see-a-flat-year-phenomenon/?tag=cbsnewsSectionsArea;cbsnewsSectionsArea.0

thought would find this of interest
Larry

[bob90245]

Doesn anyone else get the irony?

The financial media is a great, if unintentional, source of entertainment -- provided you know how to assess the welter of facts, half-truths, bald-faced lies, and scurrilous rumors continuously circulating in that world. Needing, as ever, to hold investors' attention, journalists seem to latch onto virtually any story and try to infuse it with meaning.

Just in case I have to spell it out, this quote comes from "the financial media". Or is CBS Moneywatch not part of "the financial media"?

[nisiprius]

Larry, very annoying that it came out wrong, i.e. that to my eyeball your table is consistent with the superstition.

Thought I'd try a shot at it. What the superstition says is that flat years are followed by good years, or, rephrasing, let's define a flat year as a year with a low absolute value for the return and ask: is there a negative correlation between low-absolute-value of the returns in one year with returns in the following year? Here's the plum-pudding chart



and the correlation is -0.034, virtually zero. But, darn it all, it does look as if something's happening at the very left edge. So let's just chart those years for which the return had an absolute value of less than 10%, i.e. was in the range ±10%. Now the chart looks like this



and darn it, I do think I see a bit of a downward slope, and the correlation coefficient is -0.43. Well, at this point I've done so many things that I could be guilty of torturing the data until it tells me what I want to know. The really evil thing I did was pick the zone within which I thought I saw the downward trend. But let's look it up. We are using 26 points and seeing a correlation of -0.43, and--must be a better place than my yellowing Biometrika Tables for Statisticians but I know where it is--nothing tabulated between n = 25 and 30, we'll use 30 which will overstate the significance--30 points, the 5% confidence limit (two-tailed) is 0.349, and the 1% confidence limit is 0.449. Meaning we'd just on be the hairy edge of 5% significance if it had been a properly designed inquiry.

I don't know what to wish for. A lousy year that will reveal the falsity of the superstition, intellectually satisfying but financially disappointing? Nah, let's have a great year, please, even if it means more financial porn.

Oh well. I've lived long enough to see the end of the "every President elected in a year ending in 0 dies in office" meme.

[hicabob]

nisiprius, I'm curious as to your profession? You have to be the pre-emminent data visualization expert on the board!

[nisiprius]

nisiprius, I'm curious as to your profession? You have to be the preeminent data visualization expert on the board!

Thanks! But I'm the preeminent one, that's a Bad Thing. I welcome company. And we used to have more people that did it, some of the serious MPT theorists, and I miss them. But I'm glad to see more and more people are making a practice of viewing and posting relevant growth charts. I'm a semiretired software engineer whose career has been a bit like the feather in the opening titles of Forrest Gump, was a grad student, took Statistics 101 once, had to do stuff for my thesis, etc.

And I first learned about Edward Tufte's The Visual Presentation of Quantitative Information first book in one of the Whole Earth Catalogs, read it, and it made a huge impression on me. I've bought all of his books, actually, but the most recent ones are a little self-indulgent and not quite as wonderful as the early ones.

I'd also feel better if I thought people were occasionally checking my work...

[hicabob]

And I first learned about Edward Tufte's The Visual Presentation of Quantitative Information first book

A fine book indeed - It made quite the impact where I was working at the time

[john94549]

Anybody else notice the Big Dipper (the constellation) in the lower of Nisi's two charts? Look to the right, mid-way down. The North Star, however, is missing. Bad omen?

[ftobin]

I'd also feel better if I thought people were occasionally checking my work...

Spoken like a true engineer who values code reviews :)

I had guessed you had a software development background due to an earlier post in which you were talking about differences between various languages. IIRC, some of the languages were new, some were old, and therefore I presumed you were near- or just-retired.

[nirvines88]

Anybody else notice the Big Dipper (the constellation) in the lower of Nisi's two charts? Look to the right, mid-way down. The North Star, however, is missing. Bad omen?

It must mean the economy can only dip south from here on out! NOOOO!

[nisiprius]

Anybody else notice the Big Dipper (the constellation) in the lower of Nisi's two charts? Look to the right, mid-way down. The North Star, however, is missing. Bad omen?

O...M...G! You're right! How could I have missed it?

Furthermore, the North Star, Polaris, is there. It was only missing because I arbitrarily cut the data off at 10%.

Furthermore, you can "follow the arc to Arcturus, and draw a spike to Spica!" That's the constellation Leo at the left, and whaddaya think? Is that Corona Borealis at 5% X, 20% Y? I wouldn't want to label anything that isn't really there.

[RobG]

If you turn the chart up-side-down you will see that Polaris is the back leg of Maria Sharapova doing a serve. Naked of course.

[larryswedroe]

Bob
The financial media is a general term. There are of course exceptions like Jason Zweig and Scott Burns and Jane Bryant Quinn and a few others, including my colleagues at CBS, Allan Roth and Nathan Hale

Larry

[larryswedroe]

Nisprius
Of course if you have a bad year in market generally it means VALUATIONS are lower, which in turn means that EXPECTED returns are now higher.
Now of course there is no guarantee that will happen of course, as the expected returns include a wide dispersion around the mean of the distribution.
Larry

[nisiprius]

Of course if you have a bad year in market generally it means VALUATIONS are lower, which in turn means that EXPECTED returns are now higher. Now of course there is no guarantee that will happen, as the expected returns include a wide dispersion around the mean of the distribution.

I don't see the "of course" here at all. Why couldn't the valuations be lower precisely because expected returns are lower? To say "expected returns are now higher," aren't you implicitly making some assumption, such as that the true value of any business is always stable--or that dividends never get reduced after stock prices fall--or, at least, that the true value of all American business taken collectively is always stable?

Which do you think reflects a truer view of stock prices from 1929 to about 1945? 1) Prices failed to return to a 7% real growth path due to chance fluctuation within the wide statistical dispersion expected of stock prices? 2) Prices failed to return to a 7% real growth path because American business as a whole was damaged by the Great Depression and was actually worth less?

Anyway, I think we both think the same thing: there is a pattern in the data, real in the sense that the pattern is actually there--there really were good years following flat years--but that it's within the range of things that can easily happen by chance. Very comparable to the the situation of every President elected in a year ending in zero dying in office, true seven times in a row, 1840 through 1960.

[larryswedroe]

Nisprius
There are two possible explanations for market falling, earnings fall due to bad economy (while P/Es can remain the same) or earnings can remain the same but P/Es fall
Bad bear markets occur because both happen at same time. When P/Es fall (meaning valuations) then expected returns rise, very simple. So to be clear by valuations I mean P/E.
Valuations are lower not because expected returns are lower but because perception of risk is higher, markets price for RISK.
No such assumption about stability of valuations is being made, don't know why you had that idea.
Hope that helps
Larry

[larryswedroe]

Nisprius
There are two possible explanations for market falling, earnings fall due to bad economy (while P/Es can remain the same) or earnings can remain the same but P/Es fall
Bad bear markets occur because both happen at same time. When P/Es fall (meaning valuations) then expected returns rise, very simple. So to be clear by valuations I mean P/E.
Valuations are lower not because expected returns are lower but because perception of risk is higher, markets price for RISK.
No such assumption about stability of valuations is being made, don't know why you had that idea.
Hope that helps
Larry

[nisiprius]

There are two possible explanations for market falling, earnings fall due to bad economy (while P/Es can remain the same) or earnings can remain the same but P/Es fall... by valuations I mean P/E. Valuations are lower not because expected returns are lower but because perception of risk is higher, markets price for RISK. No such assumption about stability of valuations is being made, don't know why you had that idea.

I misunderstood the word "valuation." The implicit assumption is, then, that P/E has some kind of natural "normal" value to which it tends to return.

The question, then, becomes whether a "flat" year implies a low P/E and would thus be expected to be followed by a good year.

[umfundi]

And I first learned about Edward Tufte's The Visual Presentation of Quantitative Information first book in one of the Whole Earth Catalogs, read it, and it made a huge impression on me. I've bought all of his books, actually, but the most recent ones are a little self-indulgent and not quite as wonderful as the early ones.

Ah, yes, Tufte's books are only a step away from my desk, in my office.

I always enjoyed his characterization of crosshatching patterns on bar charts and other graphs as "chartjunk".

Keith

[nisiprius]

I always enjoyed his characterization of crosshatching patterns on bar charts and other graphs as "chartjunk"

An irony is that the current version of Excel, which I use because I have it and don't want to spend money on anything else, has a "sparkline" feature in the current version--derived from Tufte's work, I assume. So someone at Microsoft knows about Tufte. Yet, Excel's charting features are about 10% devoted to producing "data ink" and 90% devoted to producing bedazzling "chartjunk." A gazillion ways of adding a data-free three-dimensional appearance to a bar chart, and not one way to produce a properly graduated logarithmic scale.

I loved his illustrations in the first book, in which charts with only a few data points had tick marks opposite the actual points--rather than a linear scale--labeled with the actual data values. An easy and sensible idea that would be trivial to implement in software, yet doesn't seem to have caught on at all.

At least one sees fewer charts with the bars shaded in with crazy unintentional op-art cross-hatching, but I think that's more due to the replacement of pen plotters with laser printers then to people paying attention to Tufte.

[555]

What if you use the Chinese calendar?

[umfundi]

What if you use the Chinese calendar?

[555]

What if you use the Chinese calendar?

Define "flat year".

[larryswedroe]

Nisprius

The implicit assumption is, then, that P/E has some kind of natural "normal" value to which it tends to return.

Incorrect again, there is no implicit assumption at all. None needed.

A low valuation means high expected return and vice versa, you don't need reversion to mean return to get the high return, just the high discount rate which generated the low P/E. Now if you get RTM (historical average) from lower than average P/E returns will be much greater, that is what happens in bull markets when discount rates fall as perception of risk rises. And of course the reverse is true. High valuations mean low expected returns. Nothing to do with RTM

Best wishes
Larry