The NYT, Magazine Cover Indicator, and Mean Reversion

Would someone please explain to the nice folks over at the NYT, or the economics department at the U.C.L.A, the concept of mean reversion, contrary indicators, and (ahem) how the national businmess press operates?  (We have discussed the magazine cover indicator previously, so those unfamiliar with it can read any of those posts at their leisure).

The ongoing innumeracy and logical fallacies that exists in this country continues to  astound. Case in point: What the NYT called "the curse of the business press." (No Applause, Please).

Here’s the relevant excerpt:   

"Chief executives who are heralded as “best manager” or “best performing” or who receive some other kind of elaborate praise from business writers almost always see their company’s stock performance suffer afterwards, according to a working paper by two assistant professors of economics at the University of California, Ulrike Malmendier of Berkeley and Geoffrey Alan Tate of U.C.L.A.

“The stock market returns of award-winning C.E.O.s’ companies lagged those of their unheralded peers by about 4 percent per year over the three years following an award,” Larry Yu writes in Sloan Management Review in summarizing the research.

What causes the decline? The academics speculate that recognition in the press could lead to the executive’s becoming distracted. “Winning an award doubles the odds of the C.E.O. penning a book, and winning as many as five awards makes a C.E.O. four times as likely to sit on five or more outside boards.”

Or it could be that as Ms. Malmendier notes, journalists are simply very good at picking people who are going to underperform."

No, no and no.

Are these folks really that logically challenged?

There are a few simple answers: First, this is yet another classic case of confusing correlation with causation. Just because two thing occur proximate to each other in time is not a sufficient basis alone for assuming that one caused the other.

Second, Investors, Reporters and Professors need to ask themselves a simple question:  "Why have these CEOs appeared on magazine covers?" Its more likely than not that they have done something that caught the attention of the investing public and eventually the media. And its also very likely that their stocks HAVE ALREADY had a great run up — far above the average 12% we see for the SPX over the very long term.

Speaking generally (yes, of course there are a few exceptions), there’s a more logical reason. What is a more likely explanation for the so-called "curse of the business press. is actually a simple case of mean reversion. By the time the mainstream press discovers the next star CEO, their stock has already put in best part of the run.

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Source:

No Applause, Please

What’s Offline
PAUL B. BROWN
NYT, August 18, 2007

http://www.nytimes.com/2007/08/18/business/media/18offline.html

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