Tag Archives: Stock Markets

The Best Example of Bad Graphs

Those of you in the UK (or elsewhere) who read the Telegraph may have noticed an article recently called “How the Fed triggered the Arab Spring uprisings in two easy graphs”. If you want the gist of it, here is the first graph:

Now, as most economists learn, correlation does not equal causation. But let’s assume for the author’s sake that he has a point. What should we think when we see commodity prices rising (starting June 2010) and the Fed’s Treasury purchases rising after the fact (around Aug-Sept 2010)? Yes, if we want to read causation, then we’d say that the rise in food prices caused the Fed Treasury purchases, and not vice versa (as the article claims).

The second graph, which we show below, displays the correlation between, well, we’re not sure. Continue reading

Why Care about Dow Jones?

Turn on CNBC, go to Yahoo Finance, or read the Wall Street Journal, and one of the most published (and sought for) indicators is the Dow Jones Industrial Average. Another is the S&P 500, along with the Nasdaq. Why is this? Is everyone who follows this number invested in the market? No, but the ups and downs of all of these indices are assumed to be a proxy for the ups and downs of the US economy. If the Dow Jones Industrial Average (DJIA) is climbing, commentators are happy. If the DJIA is losing points, however, it’s reported as bad news. Same with the S&P 500 and the Nasdaq. Is this logical?

The S&P 500 is composed of 500 companies with large market capitalization in the US, and is chosen by committee. Is is the second most followed index in the US (and possibly the world) after the DJIA, which is a composite of 30 large, publicly owned companies, also chosen by committee.

For those of you who think it might be odd that a collection of only 500 companies, let alone 30, could represent the whole economy, you’d be correct. In fact, in recent years Small and Medium Enterprises have been growing in number and are representing more and more jobs and a bigger slice of the economy. So, if over 80% of jobs are in companies that are considered SME’s and aren’t even public, why do we care so much about these indices?

The answer lies in our need for a locus of order and control. If we can equate 30 companies with the health of our economy, it is a neat and simple solution to a messy and complicated situation. It is interesting to note that this is often the same reason conspiracy theorists have their beliefs: it is easier to know someone, somewhere, is in control, than to accept randomness and chaos.

Before dipping into murky waters of psychological babble, we’d like to come back to the original idea behind what the DJIA and S&P 500 are supposed to represent, but tweak it for reality. If, (as the Economist said the Kauffman Foundation reported), nearly all job creation between 1980 and 2005 took place in firms that were less than five years old, shouldn’t we be following these sorts of entrepreneurial companies instead? Well, there is one new index that does: The Global Entrepreneurship Development Index, or The GEDI. This, as its name suggests, is a global index and divided by country (71 in total), identifying the most entrepreneurial, as well as bottlenecks impeding growth in each country. Denmark is ranked first, the United States is second, and China and India are very low on the list.

Unfortunately, for now the list is not free and is published only once a year, so chances are that CNBC and Yahoo Finance will continue monitoring 30 large companies which are of no consequence to our lives.

You can buy the Global Entrepreneurship Development Index on Amazon here.

Bringing Sexy Back to Economics… on Amazon!

Drum roll please….

Our new book is finally on Amazon! Wave goodbye to the tweed jackets, bow ties and thick-rimmed glasses because we’re bringing Sexy Back to Economics!

Our Book, Full

And since it took so long to get approved, we’ve been able to add 7 new chapters (seriously)!

Of course, for those of you with Kindle, you can still download our book to your device right here. And yes, we’ve updated the Kindle version to include our 7 new chapters as well.

If you want more details about just how we’re bringing sexy back, check out our information page right here.

OK… you can stop the drum roll now actually.

Reasons not to Invest in Stock, Part 3

In case our first and second parts of this series did not convince you, here is an article from Forbes Magazine, highlighting the mistakes most investors (yes, that means you and I) make when investing. The points it makes echo many concepts that come from Behavioral Economics:

Overconfidence. The overconfidence bias states that most people consider themselves better than average. Ask any group of people what their driving abilities are like and, on average, they will reply that their abilities are above average. Same applies to investing abilities. On the other hand, why would you compete with all the investors out there if you didn’t think you were above average?

Going with the Crowd. This, in behavioral economics, is known as Groupthink. In other words, you are much more likely to invest in stocks that other people have been talking about and investing in than equally good stocks that haven’t been mentioned as much.

Stubbornness. Two things are at work here: First of all, the unwillingness to admit defeat. Even if your stock is down 50%, if you haven’t sold it then you haven’t given up, so you might as well continue. Secondly, people grow attached to a stock. As Ariely points out in his book Predictably Irrational, people overvalue what they have. Stocks are no exception.

The only bone of contention we have with this article is its final paragraph, which states:

But keep in mind the possibility that you are fooling yourself and would do better buying index funds

We’d recommend not to rely on index funds either, since their performance still depends very much on time frame.

Our Book is Now on Kindle!

We are proud to announce that our book is now available, in its entirety and minus its girth, on Kindle!

If you don’t own a Kindle, you probably know someone who does and who deserves an excellent Birthday and/or Graduation present. And we all know nothing says Happy Birthday quite like a copy of “Bringing Sexy Back to Economics”.

Click Here for the Kindle version of our Book.

We’re Bringing Sexy Back to Economics!

Drum roll please….

Our new book is finally here! Wave goodbye to the tweed jackets, bow ties and thick-rimmed glasses because we’re bringing Sexy Back to Economics!

Our Book, Full

Our new book is available for Download, at our introductory price of $11.99!

Yes, this is a discount and no, it is not permanent, so check it out now!

If you want more details about just how we’re bringing sexy back, check out our information page right here.

Ok.. you can stop the drum roll now actually.

Government Spending vs. Unemployment

The graph at the bottom of this page is enough to make me want to buy the book.

It’s Not as Bad as You Think: Why Capitalism Trumps Fear and the Economy Will Thrive , by Brian Wesbury.

A review will be forthcoming.

Yes Virginia, Markets are Efficient

In the wake of the recent controversy surrounding Free Markets, and more specifically, the “How could we be so stupid as to believe markets could work?” statements, we feel it is time to clear the air and make a couple blanket statements:

Efficient Markets does Not mean continuous growth
It is excusable in a way. We equate efficiency with working well, and we assume that an economy which works well will continue to rise. On the other hand, for an economy to work well it will have to get rid of the dead weight companies every now and again. Schumpeter famously called this “Creative destruction” and we (not as famously) declared that once the dust settled, our economy should be better off thanks to this downturn. Lehman Brothers, Bear Sterns, AIG and the like were riddled with bad management, overly risky investment, unrealistic expectations and outright fraud. Are these companies that deserve to continue operating? And what does it take for them to stop? A financial crisis, that’s what.

Free Markets does not mean “at no cost”
Although we sort of assumed this was obvious, we have seen some misconception in this regard (this might be our fault for following AlterNet.org on Twitter). Free Markets means Free of intervention, so that market forces can operate without obstruction. It does not mean Free as in the “Buy one get one free” variety. There are obviously costs for participating in the market. If markets are efficient, the costs are entailed and understood. Every time a stock rises, someone buys and someone else sells, then when the stock falls, someone sells and someone buys. By definition, someone will have gained and someone will have lost. On the other hand, these are the risks entailed. The interesting thing is that outside of the stockmarket, there can be many participants, all of whom are winners.

No, Virgina, stocks won’t always rise
This brings us to the final point. While the first two points were more a question of semantics, this is an outright fallacy. If you had bought into the S&P 500 at the beginning of 1999, right now you would have an 8% loss, and this is not counting for inflation. You can argue that we are in a downturn. On the other hand, between this recession, the dot com bubble, the 1987 crisis, etc. we can see these downturns are more commonplace than we might have thought.
A stockmarket should, in theory, reflect the economy as a whole, which is where this fallacy arises. On the other hand, the S&P 500 (generally agreed to have the broadest scope), lost more in the 00′s than in the 1930′s, while the economy grew at around double the rate. As more online companies and small business start gaining credence and traction, the top 500 companies of the country will be having less and less influence. Expect it.

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