How Not to Be Wrong
In the great work, How Not to Be Wrong: The Power of Mathematical Thinking by Jordan Ellenberg, the author gives countless examples of how statistics – either presented with sincerity or intentional spin – can cause the reader to draw materially incorrect conclusions and take actions inconsistent with their best interests. Let’s see how this applies to our investing lives.
It is no great mystery that several growth stocks have had a great start to 2023. META is up an astounding 121% year to date. Mega-cap GOOG is up over 40% and AMZN has climbed nearly 45% since January 1st.
If you take this data in isolation, you might think that META is in massively overvalued, perhaps in bubble territory. I mean, a stock’s more than doubling in a few months harkens to the glory internet bubble days. Indeed, TV financial pundits are marveling at the massive moves of some of these stocks and speculating they are due for material declines.
But this looks at things entirely backwards. The point is, these stocks just went through a massive correction, META for example having declined nearly 70% in 2022 alone. What I call “The Ugly Truth of Math” indicates that a stock declining 50% must double to get back to break even. A stock that has declined 80% must increase by 5 times to break even. So even though the gains seem so large this year, they are more a reflection of the huge losses these stocks have recently experienced, not necessarily that they are in nosebleed territory.
Using Jan 1st, 2023 is an arbitrary starting point skews the data. If you expand the timeline just a bit – widen the scope as it were - you will see that META is still over 30% below its highs and would have to increase by another 40% just to get to ‘break even’ for those who bought the stock at its peak less than 2 years ago. AMZN still needs to gain a massive 50%+ just to approach prices seen less than 24 months ago.
So, when you hear statistics being bandied about, take a moment to gain some perspective, as in many cases, the point the commentator is making may be misleading – intentionally or otherwise.
Put Away That Crystal Ball
Many people pray to have a crystal ball when it comes to things like economic data, fed decisions, what headlines will read, etc. But be very careful what you wish for. If I had given you headlines from prior economically challenging times and you had made stock market decisions based on these, in many cases you would have lost boat loads of money when the stock market reacted the opposite way the headlines would suggest they ‘should.’ Since these unpredictable conditions will surely exist across your investment holding timeline, you should aim to own companies for the long term that can do well throughout a variety of economic cycles, political environments, etc.
Let’s look at some recent headlines blaring across mainstream and financial media:
“U.S. DEBT DEFAULT WOULD RICOCHET AROUND THE WORLD!”
“FITCH PUTS U.S. RATING ON NEGATIVE WATCH.”
“HELL NO! REPUBLICANS WON’T DROP DEMAND FOR WORK REQUIREMENTS AS FINANCIAL DISASTER LOOMS.”
On each of the days these headlines were blaring, stocks rallied - hard.
As I mention in my new book The Compound Code, it is not possible to consistently predict the outcome of macro-economic, political, or other events, let alone how the stock market will respond to the event’s outcome. The good news is that you do not need a crystal ball to achieve your investment and financial goals. In fact, the less you engage in the predicting business (or listening to pundits who get paid to do it) and the more you focus on planning & executing said plan (either on your own or with a financial professional), the better off you will likely be, both in terms of your long-term investment returns (by definition anything can happen in the short term; that is the main point) and, more importantly, priceless peace of mind.