If you only learn one thing today, let it be this:

It took me a long time to come to the understanding that the economy and the stock market are only second cousins, that they’re not twin brothers as most people tend to believe.

Since being taught this and shown the definitive evidence, I’ve devoured papers and studies on the subject and have seen this truth borne out from a variety of different research methodologies. I’ve also freed up much of my time that used to be spent reading global macro newsletter BS. While many of these newsletters contain several interesting observations and statistics, almost every one of them then goes on to form the wrong conclusions or an uninvestable premise.

Economic forecasts are not terribly helpful for the purposes of asset allocation because they do not (cannot!) allow for the fact that human market participants will not necessarily react as we expect they will.  Sentiment and psychology and politics and natural disasters cannot be accurately and mathematically represented in any forecasting model and everybody knows it.

Paul Lim casts a spotlight on this perennial disconnect this weekend with a column at the New York Times that cites a key Vanguard Group report.

It should be noted that Vanguard does have a particular bias – they are the anti-active management shop and the idea that markets and asset classes can be timed is anathema within their vaunted Valley Forge castle keep and mead halls.

But! But their take on the predictive power of various economic gauges and market valuation metrics is not to be ignored. If you only learn one thing today, let it be this (emphasis daddy’s):

Roger Aliaga-Díaz, senior economist at the Vanguard Group, says investors shouldn’t be surprised about the seeming disconnect between basic economic variables and stock market performance. He and his colleagues at Vanguard recently studied equities’ returns going back to 1926, looking specifically at the predictive power of important variables. Those include market price-to-earnings ratios, growth in gross domestic product and corporate profits, consensus forecasts for gross domestic product and earnings growth, past stock market returns, dividend yields, interest rates on 10-year Treasury securities, and government debt as a percentage of G.D.P.

Their conclusion was that none of these factors — which investors often cite when explaining their moves — come remotely close to forecasting accurately how stocks will perform in the coming year. “One-year forecasts of the market are practically meaningless,” Mr. Aliaga-Díaz says.

Even over a 10-year time horizon, considered by many investors to be long term, only P/E ratios had a meaningful predictive quality. Since 1926, those ratios, based on 10 years of averaged earnings — a gauge popularized by the Yale economist Robert J. Shiller — explained roughly 43 percent of stocks’ performance over the following decade.

Of course, “that means about 55 percent of the ups and downs in the market can’t be explained by valuations,” Mr. Aliaga-Díaz says. What about economic fundamentals like G.D.P. and corporate earnings growth? Over the course of a decade, those factors had even less predictive power over future returns.

No long-term efficacy and no short-term efficacy. And yet we obsess over these things on a daily basis, sometimes making huge changes to our portfolios and even our business plans as a result.

At my shop, we watch weekly charts and base decisions on monthly charts. We look at trends and rolling multi-month moving averages in economic reports as opposed to single-variant data points. I’m not saying this approach is always right or is certain to do better than any other approach. What I am saying is that it keeps us sane and it enables us to ignore so much of what distracts so many others – which I believe will have more positive effects than negative effects over the course of a career.

How can it not?


The Economy and Stocks: A Big Disconnect (New York Times)

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. low cost vans commented on Sep 20

    … [Trackback]

    […] There you will find 27997 additional Info on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  2. blazing trader review commented on Sep 23

    … [Trackback]

    […] Info to that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  3. bitcoin evolution online commented on Oct 03

    … [Trackback]

    […] Find More on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  4. 먹튀사이트 commented on Oct 07

    … [Trackback]

    […] Find More Information here on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  5. 밤토끼시즌2 commented on Nov 29

    … [Trackback]

    […] Find More here to that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  6. replica rolex commented on Dec 17

    … [Trackback]

    […] Information on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  7. td login commented on Dec 28

    … [Trackback]

    […] Read More Information here on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  8. Skrota bilen Göteborg kostnad commented on Jan 09

    … [Trackback]

    […] Read More on on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  9. sign-in tangerine commented on Jan 14

    … [Trackback]

    […] Find More on to that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]

  10. wig commented on Jan 19

    … [Trackback]

    […] There you will find 31793 more Information on that Topic: thereformedbroker.com/2012/12/16/the-one-thing/ […]