IN THIS ISSUE

Specious Statistics

There was a phenomenal exchange in the 2015 Senate hearing titled “Data or Dogma: Promoting Open Inquiry in the Debate over the Magnitude of Human Impact on Earth’s Climate”. The hearing was convened by Senator Ted Cruz as chairman of the Subcommittee on Space, Science, and Competitiveness.

Senator Cruz opened the hearing with this statement:

“This is a hearing on the science behind claims of global warming. Now this is the science subcommittee of the Senate commerce committee, and we are hearing from distinguished scientists sharing their views, their interpretations, their analyses, of the data and the evidence. Now I am the son of two mathematicians, two computer programmers and scientists, and I believe that public policy should follow the actual science, and the actual data and evidence, and not political and partisan claims that run contrary to the science and data and evidence.”

As you can imagine, the issue was politicized back then as it is now. Senator Cruz’s opening statement went on to critique “global warming alarmists” and presented a range of dubious evidence that global warming is not supported by science. One example was this graph showing “No global warming for 18 years 9 months”:

Now, unlike Senator Cruz, zero of my parents were mathematicians and computer programmers and scientists. Also unlike Senator Cruz, I am a mathematician, and I wondered why they chose 18 years 9 months for the domain of this chart. Seems a bit selective, no?

Well then. One of the witnesses, Dr. David Titley (Rear Admiral, USN (ret.), Professor of Practice in the Department of Meteorology at Pennsylvania State University, and Director of the Center for Solutions to Weather and Climate Risk, rebutted the Senator’s claim this way:

“If you take off that top, really big spike, and you take that out, you start getting the upward bias. This is what people do when you start looking at these relatively arbitrary times, is you start with a really high number at the left hand side, and that kind of influences your basically your linear trend. So when you start looking at things like every decade, you have an upward trend in the data, and that’s from the World Meteorological Organization.”

There we go - by carefully selecting the starting point to be a peak in volatile data, one can make the subsequent data over a smaller window look different from the long term trend.

Phil Mason rebuts this argument, also known as the “Global warming stopped in 1998” argument, in this video. Here is a nice animation showing how the 18 year 9 month window fits into the long term data:

I have to believe Senator Cruz is aware that the temperature data go back more than 18 years 9 months, and therefore he knowingly uses cherry-picked data to support his broader ideological agenda. Informed observers should ask “Why did they choose 18 years 9 months?” to discover this statistical manipulation and avoid making poor decisions based on faulty evidence. Because in volatile data, short-term intervals can have trends that run counter to the long-term trend.

You know this is all leading somewhere…

Consider this article from Bloomberg, Hedge Funds That Charge Most Tend to Perform Best, Barclays Study Shows:

Hedge funds have fresh ammunition to push back against detractors who have long criticized their hefty fees.
The firms that charge the most -- often the industry’s biggest names -- tend to produce better returns over time than less expensive competitors, according to a recent study by Barclays Plc’s Capital Solutions group, which examined about 290 hedge funds, their fees and the ultimate payoff.
Multi-manager funds, which use pods of traders to invest across markets, were among the best performers. Those that charge full pass-through fees -- meaning clients pay for the cost of operations, portfolio-manager compensation and other expenses -- “generated superior net returns,” according to the study. They also produced more alpha, or excess returns over benchmarks, than peers who charge only partial pass-throughs or none at all.

Barclays argues that investors should be okay with paying a fund’s full fees, rather than the fund’s management company paying some or all of those fees, because “Multi-manager funds with full fees often produce the strongest net returns.”

How can this jive with the long-established evidence, like the biannual SPIVA (S&P Indices Versus Active) reports, that lower fees lead to higher returns for investors and that active management’s high fees do not produce higher net-of-fees returns to investors relative to passive indexing?

The answer is… it cannot. The Barclays study selected a relatively narrow window, 2019 thru June 2022, during which COVID-19 and global inflation disrupted economies and financial markets in historically uncommon and perhaps even unprecedented ways.

Putting this into a different perspective, even in the most optimal conditions for active managers to beat the S&P 500 index, Almost Half of Stock Pickers Beat the Market in Early 2022 Selloff (WSJ) - choosing which fund managers will outperform the Index remains essentially a coin-flip in these supposedly favorable stock picking conditions. Of course in more normal market conditions active managers very Likely will revert to their usual SPIVA-documented underperformance.

Until investors evolve the clairvoyant foresight to foretell such events in advance, investors cannot systematically capture the advantages established in cherry-picked studies. Some investors will get it right some of the time (luck), but we cannot confuse luck with systematic skill. Investors should rely on long term studies in order to achieve long-term objectives. When markets inevitably revert back to their more normal behaviors, investors who make decisions based on short-term cherry-picked intervals will find that their strategies lose congruence with normalized market behaviors and Likely will realize inferior outcomes.

That’s why the Barclays findings are best understood as specious statistics.

For further reading:

Paulos, John Allen. A Mathematician Reads the Newspaper. Basic Books, 1995. Naturally the news is dated, but regrettably the misleading tactics persist today.

Darrell Huff. How to Lie with Statistics. Norton, New York, 1954. An even older classic in statistics.

September Selloff + Buffett Wisdom

Equities markets had a rough September, with the S&P 500 Index down 9.21%, notching the worst monthly performance since March 2020’s 12.35% decline. And we have to look all the way back to February 2009 for the next-worst monthly performance drop of 10.65%. Investors are not accustomed to this level of volatility, and it shows.

Which makes this month an opportune time to revisit this Warren Buffett wisdom:

"Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”

Source: Top 10 Warren Buffett Quotes on Investing and Famous Lines

In that the S&P 500 Index is now at a roughly 24.3% drawdown from its January 2022 high, essentially only halfway to Buffett’s 50% threshold for risk tolerance, September’s panic-stricken sellers offer enticing opportunities to “panic-tolerant” investors.

ONE MORE THING…

Single-Bet Market? Complex markets are never this simple. “Overall, this remains a single-bet market. If you believe inflation will come down by itself and the Fed responds by lowering rates next year, stocks and corporate bonds make sense. If you think the Fed will do what it says, they’re still overpriced.” Markets Keep Making the Same Mistake About Inflation - WSJ
Bill Ackman’s buy signal. “I think once people realize the Fed doesn’t have to keep increasing rates, and will soon be taking rates down, that’s kind of a buy signal for markets. And so the question is how far in advance does the market predict that kind of outcome? I think if people see inflation come off 8.5, you start to see a pretty powerful continuing trend, then I think people will expect at some point the Fed to ease. But what they’re not going to do is take rates to 4% and see a good inflation print, and then start taking interest rates down again. They’re not going to make that mistake.” Billionaire investor Bill Ackman: The Fed has to raise rates to 4% or more
Mark Spitznagel is Fed up. "The Fed is actually trying to lead us to believe that they are prepared to tighten into a recession, which of course is a ridiculous prospect," Spitznagel said. "And I think the Fed knows they're not going to do this. And the market ultimately, I think, will come to that conclusion." Mark Spitznagel: Expect Inflation to Be 'Elevated Forever'

David Kelly sees a patient Fed. “softening inflation and cooling demand across the economy should allow them to follow-up the hawkish rate hike with some patience over the next few months.” David Kelly, LinkedIn

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