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Stocks and the Snowstorm

Posted by: Ben Steverman on February 12, 2010

The snow that buried much of the eastern United States in the past week has stretched government budgets and slowed home-buying.

The wave of blizzards could also hurt financial markets in the coming weeks. The reason: Weaker-than-expected economic data.

Joseph LaVorgna, chief U.S. economist at Deutsche Bank (DB) writes Feb. 11:

In the past, major winter weather events have had a measurable impact on a range of economic indicators including employment, industrial production, retail activity and real estate/construction.

In January, non-farm payrolls declined 20,000. In February, many economists were hoping for a payroll increase. That could be a crucial sign that the economic recovery is on track – if, that is, job market improvements aren’t stymied by snow.

The monthly employment report includes a measure of workers kept from their jobs by bad weather. During big snow storms in February 2007, for example, 505,000 workers were impacted by the weather, and in February 1994 it was 536,000. LaVorgna thinks the effects of this month’s snowstorms could match the “Blizzard of 1996,” “surpassing even Hurricane Katrina”: In January 1996, 1.85 million workers missed work because of wintry weather.

The final damage of this month’s snowfall won’t be known for a while. Yet another snowstorm is moving into Texas and other southern states.

The good news, according to LaVorgna, is that February’s slowdown in economic activity is likely to be followed by a “catch-up” in March. So while he is adjusting February economic predictions, he doesn’t expect a major impact on the quarter overall.

Reader Comments

Arthur Regen

February 12, 2010 3:03 PM

Dalbar, the Federal Reserve and Dr. Krugman Report Zero Wealth Creation For the Last 20 Years

Why is there such a disparity between the gross returns of 7- 8% for the average investor and the net real returns of 1- 2% after fees, expenses, taxes and inflation confirmed by Dalbar, the FRB and by Dr. Paul Krugman?

Rather than bemoan this sad state of affairs and since it is unrealistic to expect expenses, taxes and inflation to be drastically reduced any time soon as some have advocated, a better approach was to find out what controllable factor(s) are responsible for this corrosive drag on performance.

Many fees and expenses are controllable; the trick is to restrict selections to “no-load/no-fee” funds that also beat the S&P 500. These funds incur minimal additional acquisition costs giving the fund investor an initial, but limited, boost in returns.

Why should the average investor be subjected to a 95% chance of zero wealth creation over a lifetime of employment?

Why do current methods of fund selection deny millions of investors access to wealth creation and lose trillions of dollars annually?

Most investigators and writers deny the role of past performance in indicating persistency. Instead they favor factors as: manager’s tenure, low or no loads, low cost ratios, low turnover … to improve persistency.

Our research since 1994 supports the view that performance accounts for at least 95% of persistency while non-performance factors account for no more than 5%. The industry relies on the 5% to explain 95% of the problem.

Using 5% of the solution to a problem no matter how cleverly crafted is like trying to climb Mt. Everest without oxygen.

This is the precisely the current situation.

After analyzing the patterns of hundred of millions of data cells since 1994, the culprit was found. It was "adverse selection", which is the systematic selection of more losers than winners usually on a 75:25 ratio basis, caused by an overwhelming number of losers. By reversing these odds, mathematically, many times more winners than losers can be picked.

Consider a container of 10,000 marbles. Each marble represents a fund. Each fund has an equal chance of being selected. Suppose 2,500 funds are winners (funds that beat the S&P 500) and 7,500 funds are losers (funds that do not beat the S&P 500). With millions of selection (investor) trials, there will always be a 3 times greater chance of selecting losers than winners in the precise, predictable 3 to 1 ratio.

Unless the 7,500 losers can be objectively removed from the container, the laws of probability tell us there will always be a 3 times greater chance of selecting loser funds than winners unless a science-based intervention takes place to reverse the adverse selection process.

A winner is defined as a fund whose performance consistently outperforms the Standard & Poor’s 500 Stock Index over time.
A loser is defined as a fund whose performance consistently under performs the Standard & Poor’s 500 Stock Index over time.

There is a widely held belief among financial writers and scholars that past performance cannot guarantee or even indicate future results. This intuitive statement is required by the SEC to appear in every fund prospectus which gives it authority and credence. Yet in reviewing the literature since 1952 not one well-designed study has appeared to prove past performance does "not" indicate future results.

Let’s take a look at some of the underlying principles at issue here.
First, there is the concept of "repeatability” or “persistency”. This is the likelihood that last year’s benchmark returns will repeat in the following time frame. Surprisingly, there is no general agreement among investigators concerning persistency. There is some token agreement that a 1, 2, 3, 4 year benchmark beating returns will repeat in years 2-5 despite the fact that 4-5% of funds do not survive each year. This is the so-called” the survivorship bias". In selecting funds, the effect of the survivorship bias upon persistency has lately been softened, as it should, by some investigators. However, limiting selections to funds with 10, 15, or 20 years of history would eliminate the bias but impose the much more severe penalty of depriving investors access to many superior performing funds with lesser years of history.

Technical knit-picking aside, isn’t it time the financial services industry stopped relying on unverified anecdotes masquerading as information and begin using solid, proven scientific principles to help fulfill their trusted mission of helping investors create wealth and gain trillions of dollars annually?

Is it any wonder, on average, trillions of investment dollars needlessly produce zero wealth after a lifetime of employment?

Arthur Regen

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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