Why our economic measures are dangerously incomplete
The economist cited below used to come by periodically and give talks at Sanford Management Co when my wife was an investment manager there. This excerpt below dates from Friday, March 20, 2020.
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I get that the Federal Reserve and the government feel they have to do something. But their tools are generally geared to helping Wall Street, not Main Street. I think this note from Woody Brock sums it up very well.
More on the Crisis and the Markets
Two weeks ago, I sent out a crisis memo warning that the market could soon drop to 17,500 on the Dow. I stressed that the true threat to the economy and to profits and employment was not only interruptions in the supply chain, but more importantly the first implosion of the SERVICE sector we have ever seen.
This is now just what we are seeing as movie theaters, airlines, “events” of all kinds, schools, universities—all closed down. And the Dow today is down from 29,000 to 21,000. A further drop to our predicted 17,500 could occur within a week or two. In this brief Memo I wish to add a few points regarding the volatility of the market.
Pricing Model Uncertainty
The main point concerns the role of what we have called “Pricing Mode Uncertainty” (PMU)—a concept we introduced some 14 years ago.
Our fundamental theorem was that the greater the amount of PMU there is in a market, the greater the degree of price overshot upward and downward there will be.
The degree of PMU rises with the degree to which investors admit that they do not understand the mapping of “news” into prices.
In the efficient market theory, it was simply assumed that all investors would—upon hearing the news—agree on the “correct” new price of the asset. There was thus no PMU and thus very low volatility.
In the current case where no one understands what the “news” really is, much less how it will impact asset prices, PMU is MAXIMAL thus implying huge price swings of the kind we have and will experience.
Intuitively, the reason underlying our theorem is that the greater the PMU level, it will be rational for all investors to drive price trends much further up and down. The logic is fascinating—the math very complex.
One very important form of investor ignorance today concerns the markets view that it is prospects for corporate earnings that will matter most. This is wrong.
What will matter are the collapse in profits and survivability of millions of privately owned proprietorships and partnerships whose profits are not even included in index earnings data.
It is these firms who could end up firing millions of workers and going under. THIS is what will impact Main Street and unemployment—often long before official earnings of large corporations are even computed.
The data we have for understanding the lives and behavior of these small firms that employ most Americans is sparse and scarcely looked at.
This is one further reason not to listen to data-junkies or self-styled “quants” who loathe anything subjective.
This is the time for very subjective judgments—backed up by compelling deductive LOGIC of a kind that has all but disappeared in today’s rage for “evidence-based truth”—a fatuous concept at best.
=================
begin excerpt.....
I get that the Federal Reserve and the government feel they have to do something. But their tools are generally geared to helping Wall Street, not Main Street. I think this note from Woody Brock sums it up very well.
More on the Crisis and the Markets
Two weeks ago, I sent out a crisis memo warning that the market could soon drop to 17,500 on the Dow. I stressed that the true threat to the economy and to profits and employment was not only interruptions in the supply chain, but more importantly the first implosion of the SERVICE sector we have ever seen.
This is now just what we are seeing as movie theaters, airlines, “events” of all kinds, schools, universities—all closed down. And the Dow today is down from 29,000 to 21,000. A further drop to our predicted 17,500 could occur within a week or two. In this brief Memo I wish to add a few points regarding the volatility of the market.
Pricing Model Uncertainty
The main point concerns the role of what we have called “Pricing Mode Uncertainty” (PMU)—a concept we introduced some 14 years ago.
Our fundamental theorem was that the greater the amount of PMU there is in a market, the greater the degree of price overshot upward and downward there will be.
The degree of PMU rises with the degree to which investors admit that they do not understand the mapping of “news” into prices.
In the efficient market theory, it was simply assumed that all investors would—upon hearing the news—agree on the “correct” new price of the asset. There was thus no PMU and thus very low volatility.
In the current case where no one understands what the “news” really is, much less how it will impact asset prices, PMU is MAXIMAL thus implying huge price swings of the kind we have and will experience.
Intuitively, the reason underlying our theorem is that the greater the PMU level, it will be rational for all investors to drive price trends much further up and down. The logic is fascinating—the math very complex.
One very important form of investor ignorance today concerns the markets view that it is prospects for corporate earnings that will matter most. This is wrong.
What will matter are the collapse in profits and survivability of millions of privately owned proprietorships and partnerships whose profits are not even included in index earnings data.
It is these firms who could end up firing millions of workers and going under. THIS is what will impact Main Street and unemployment—often long before official earnings of large corporations are even computed.
The data we have for understanding the lives and behavior of these small firms that employ most Americans is sparse and scarcely looked at.
This is one further reason not to listen to data-junkies or self-styled “quants” who loathe anything subjective.
This is the time for very subjective judgments—backed up by compelling deductive LOGIC of a kind that has all but disappeared in today’s rage for “evidence-based truth”—a fatuous concept at best.
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