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Alpha Theory Blog - News and Insights

« July 2011 | Main | September 2011 »

1 posts from August 2011

August 18, 2011

SuperFreakonomics on the Macro Economy

Freakonomics” is a New York Times best-seller written by Steven Levitt, a professor of Economics at Chicago, and Stephen Dubner, New York Times writer, that discusses how our common assumptions about what are true are many times wrong. The book was a smash hit and was followed up by “SuperFreakonomics.” In “SuperFreakonimics”, Levitt, an economist, explains why they do not discuss macroeconomics in the book:

“Mainly because the macroeconomy and its multitude of complex, moving parts is simply not our domain. After recent events, one might wonder if the macroeconomy is the domain of any economist. Most economists the public encounters are presented as oracles who can tell you, with alluring certainty, where the stock market or inflation or interest rates are heading. But as we’ve seen lately, such predictions are generally worthless. Economists have a hard enough time explaining the past, much less predicting the future. (They are still arguing over whether Franklin Delano Roosevelt’s policy moves quelled the Great Depression or exacerbated it!) They are not alone, of course. It seems to be part of the human condition to believe in our own predictive abilities-and, just as well, to quickly forget how bad our predictions turned out to be.”

This is a good reminder for investors to focus on their core competencies. As a stock picker, macro forecasting is probably not a productive use of energy. It seems more manageable to properly gauge the prospects of an individual company and not those of the overall economy. As Bill Ackman of Pershing Square says:

"We spend little time trying to outguess market prognosticators about the short-term future of the markets or the economy for the purpose of deciding whether or not to invest.  Since we believe that short-term market and economic prognostication is largely a fool's errand, we invest according to a strategy that makes the need to rely on short-term market or economic assessments largely irrelevant."

Of course the macroeconomy is critical to the success of any individual company. It’s just that the market and economic direction are multi-variable equations with thousands of inputs.  You can find two Nobel Laureate economists with well-defended theses for divergent directions of the US economy.  If they cannot figure it out, why should you try?  Mental capacity is a precious commodity and should be directed to what is knowable. This does not mean we ignore where we currently stand economically. Just be mindful to redirect your energy if you slip towards macro forecasting.