Posts filed under “Mathematics”
“He can take a model and turn it into a narrative”
Right after the election, Felix wrote a post “When quants tell stories.” Clever as it was, I had issues with the underlying premise – namely, that the value of Nate Silver’s modeling lay more in the narrative tale as told by Silver himself and not the underlying mathematics of statistical probability analysis.
As I read this, I kept thinking “Not exactly.”
I have been meaning to address this for some time, but a hurricane and a few weeks of no electricity got in the way. Before this gets away from me, I wanted to look back to see where I concur with Felix’ assessment, and where we disagree. It is an interesting story and an important idea – but there are a few specific points that are worth discussing.
Let’s start with the money quote:
“If you think that the value of Nate Silver is in the model, you’re missing the most important part: there are lots of people with models, and most of those models are pretty similar to each other. The thing which sets Silver apart from the rest is that he can write: he can take a model and turn it into a narrative, walking his readers through to his conclusions.”
That’s the paragraph that bothered me the most. We both agree that Nate can write – he is an effective communicator, informing his readers about a moderately complex statistical model in a way that is both informative and entertaining.
Its the rest of that paragraph that I had an issue with:
-Lots of people had models, which ranged from okay to terrible
-Most of the models differed significantly from each other
-Lots of people told interesting stories, but they got the narrative and the conclusions wrong
-A few people had models that got it right; some were good, others lucky.
Despite those errors, what caught my interest as an investor was the discussion about Narratives. It is in exactly this context that I want to discuss what a “Narrative” is conceptually, and what it means to those who toil in the Capital Markets.
It is more than just a story, rather it was a way to look at and describe the world:
-Narratives are about selling a perspective
-Narratives typically focus on squishier, less quantifiable aspects of an issue
-Narratives often hit emotional buttons, making the reader feel good about the story.
-Narratives are about the outcome, not the process.
-Models are about process;
-Good models produce a consistent process, which is more important than any single result.
In the world of investing, the Narrative is how a given stock or investment thesis gets sold. Narratives are how the threads of the story weave a tapestry that leads to an action: Buy this stock, sell this mutual fund, vote for this candidate.
Whenever a broker is pitching a stock to someone, there will invariably be a statement along the lines of “What’s the story with this stock?”
The answer usually involves a narrative that discusses some combination of the following:
-Growth over competitors
-Penetrating new markets
-Expansion overseas (China!)
Taken collectively, the stock narrative makes for a compelling story. Where it falls apart is when any of these items are closely scrutinized — the past track record of these inputs is found wanting.
Ask yourself: Who has the acumen to look at a management team and draw a conclusion about future stock growth? Almost nobody (in my experience). What is the narrator’s track record doing stock picking based on just that (or anyone elses for that matter)? The Narrator’s assessment of new products, markets, takeovers, etc. — how good has it been? These hot button issues simply fall apart as a method of selecting stocks that will outperform over either the short or long term.
However, there is an enormous difference between being able to communicate what the mathematics is informing you of, and living and dying by a narrative (often sans data). Consider Peggy Noonan — a compelling wordsmith, best selling author, and former speechwriter for Ronald Reagan. She and other non modeling story tellers constructed terrific narratives about a variety of emotional issues, none of which statistically mattered.
My favorite example was the yard signs in Florida reflecting an advantage for Romney in enthusiasm amongst his political base. There are very obvious modeling issues with that: What was the method for measuring those signs? How widespread was this nationally, and more importantly, in swing states? What is the past correlation between numerical signage advantages and election outcomes, etc?
Looked at that way, the narrative approach which only feigned a measure of statistical accuracy utterly failed. The tellers of these tales helped make themselves feel better emotionally, but these narrations did nothing for their forecasting acumen.
And that is the primary problems with Narratives: They exist to make us feel better — about a stock purchase, an election or even ourselves.
Humans are fond of using narratives to describe the world around them. Perhaps it is a vestige left over from when we had no written language. Narratives were how we passed along crucial information in a memorable way. The depiction of facts and figures simply was not a compelling form of communication to hunter gatherers.
Investors need to remember this whenever they are told a story. Narrative may be entertaining, but they won’t make you money.
Lessons from the 2012 election (Washington Post, November 10 2012)
Nate Silver and the Lessons of 2012 (November 6, 2012)
When quants tell stories
Reuters November 7, 2012
Over the years, I have been rather annoyed (perhaps too much) at the annual foolishness over Black Friday forecasts. Each year, we hear breathless predictions of ridiculous increases in consumer spending — holiday shopping rises 16% this season! — which turn out to be wildly over-optimistic, and are never confirmed by the actual data.
I’ve blogged about this annually for the past decade. Carl Bialik, the WSJ’s numbers guy, did a great piece on this a few years ago (Holiday Sales Numbers Don’t Add Up) but other than that, there is not alot of MSM recognition of the issue. I finally wrote it up for the Washington Post last year: Did Black Friday save the season? Beware the retail hype.
This year, the idea seems to have spread into the mainstream: Lots of coverage about it, with a few choice quotes from you know who tossed in for good measure.
Here is the The Globe and Mail:
“Barry Ritholtz, chief executive officer of Fusion IQ, a New York investment tool firm, is a long-time skeptic of early survey results. Not only are they released too early to compare to actual sales numbers, he says, but their measurement techniques are simply too indirect.
Foot-traffic assessments don’t properly separate browsers from buyers, Mr. Ritholz said. And he’s even more critical of surveys asking shoppers how much they plan to spend – which is how the NRF produces parts of its results. “Humans are terrible at forecasting their own behaviours,” he said.”
“Barry Ritholtz, director of equity research at Fusion IQ, takes to his popular blog every year to bemoan the “wildly optimistic” surveys that the media quotes at the end of Black Friday weekend.
Without fail, he says, the reports exaggerate consumer enthusiasm. He pointed to last year’s National Retail Foundation’s claim that sales had spiked by 16 percent – which, if true, would have been a record-breaking sum. There was no apparent attempt to check the data later on, but economists generally agree that consumer spending increased by less than 6 percent over the entire 2011 holiday season . . .
“You should be reluctant to draw too big a conclusion from one day,” Ritholtz said. “As we’ve seen, it never lives up to the hype. In fact, part of the reason there’s so much hype and false signals is there are so many people trying to get a read into that one day, far more than what you should typically be willing to see in one day. This is an economy, not an event.”
“As financial pundit Barry Ritholtz wrote last year: No, retail sales did not climb 16 percent. Surveys where people forecast their own future spending are, as we have seen repeatedly in the past, pretty much worthless. We actually have no idea just yet as to whether, and exactly how much, sales climbed. The data simply is not in yet. The most you can accurately say is according to some foot traffic measurements, more people appeared to be in stores on Black Friday 2011 than in 2010.”
So the good news is that print media has figured this out. Now, let’s see if television and radio can get their story straight . . .
Did Black Friday save the season? Beware the retail hype. (Washington Post, December 4, 2011)
Retail Sales Disappoint on False Black Friday Reports (December 13th, 2011)
No, Black Friday Sales Were Not Up 16% (not even 6%) (November 28th, 2011)
Entering the Holiday Shopping Season (Beware Surveys!) (October 28th, 2009)
Spinning Black Friday Retail Sales (December 1st, 2008)
Repeat After Me: Spending Surveys Are Meaningless (October 2007)
More Bad Data from the NRF? (November 2006)
Holiday Sales Numbers Don’t Add Up (December 1st, 2005)
Don’t look to Black Friday for clues to the market
The Globe and Mail Thursday, Nov. 22 2012
Despite Hype, Black Friday Can’t Predict Holiday Shopping Patterns
NBC, Nov 21, 2012
Lies, damned lies and Black Friday sales
Constantine von Hoffman
MoneyWatch, November 21, 2012
1. Breakout Star Of The Election Season You don’t have to be running to win. You don’t have to be number one. Concentrate on being a member of the scene and surviving. 2. Paid His Dues We’re so used to here today, gone tomorrow. Young people thrust into the spotlight who then disappear. Rebecca Black…Read More
I recently had an interesting conversation with a Real Estate agent (whom I know for a long time) about local sales and prices. She had seen an increase in total units, but was surprised at the increase in home prices that have been reported. Having sold multiple identical units in the same waterfront condo complex,…Read More
This Sunday morning we reach the ninth in our series of investor errors. This one’s title comes from the standard Wall Street boilerplate disclaimer that is on everything investment related: “Past performance is no guarantee of future results.”
Despite its ubiquity, it is routinely ignored by investors.
Every hot mutual fund manager who is on the cover of some investing magazine, every trader who made a one shot killing, every strategist who accidentally stumbled into a lucky call: Many people chase the gurus, looking for a little magic that will make them wealthy.
Sorry, it doesn’t work that way.
Consider: The Morningstar mutual fund rating 5 star ranking attracts lots of new investors and lots fresh dollars. The primary factor in the rating is (can you believe it?) past performance. This despite a Morningstar study that found 5 star funds mostly underperform — my assumption is it’s a case of simple mean reversion. As it turns out, the fund’s expense ratio is a much better predictor of performance (See results here).
When making any investment, make sure you are not merely chasing a hot quarter or two. Note that there are 10,000 hedge funds and 12,000 mutual funds and very few consistent managers generating sustainable, repeatable returns.
1. Excess Fees
2. Reaching for Yield
3. You Are Your Own Worst Enemy
4. Asset Allocation vs Stock Picking
5. Passive vs Active Management
6. Mutual Fund vs ETFs
7. Neglecting the Long Cycle
8. Cognitive Deficits