IN 2005, COMEDIAN Stephen Colbert popularized the word “truthiness.” This term, if you aren’t familiar with it, refers to something which seems like it should be true, but isn’t actually supported by evidence. Are stock market pundits guilty of truthiness? To answer the question, let’s look at a recent event.
First, some background: In the life of an investment analyst, there’s a rare but dreaded phenomenon known as a “profit warning.” This occurs when a company can tell, based on preliminary numbers, that its quarterly results are going to be truly dismal and far below expectations. When companies find themselves in this uncomfortable situation, they move quickly to disclose what they know, rather than waiting and surprising everyone on the regularly scheduled quarterly conference call.
That is what just happened to Apple for the first time in 16 years. In a letter to shareholders, CEO Tim Cook warned that iPhone sales had been weak and that revenue would be down $4 billion from last year. The stock price reaction was swift: down 10% the next day.
In response to this event, market pundits immediately took to TV and radio with these opposing viewpoints:
Apple detractors were quick to point out that “trees don’t grow to the sky.” In other words, companies can’t keep growing at a rapid clip forever. Just as IBM, Xerox and BlackBerry have all seen their stars fade, it is now Apple’s turn. To support their view, detractors point out that iPhone sales have plateaued and that Apple hasn’t delivered any truly new products in years. To further support their view, detractors pointed to Cook’s letter, in which he seemed to be grasping at straws, blaming slow iPhone sales on things like the availability of inexpensive battery replacements.
Apple supporters, on the other hand, took the position that “this too shall pass.” In their view, the stock market is simply overreacting. They see Apple’s stock as a bargain at these lower prices. After all, Apple is still the smartphone leader in the U.S. Last year, they sold an astonishing 217 million phones. To bolster their view, Apple supporters point to Cook’s letter, which noted a number of non-Apple-specific issues, including exchange rates and trade tensions with China. In other words, Apple is just fine. Sure, it wasn’t a great quarter, but Apple was simply the victim of factors beyond its control.
What should you conclude from these contradictory viewpoints? Is one side or the other guilty of truthiness? When you hear these types of things on TV or see them quoted in the newspaper, who should you believe?
My view is that you should ignore them both—but not because either is guilty of truthiness. Market analysts are all trained to rely on data. You can see that in the above examples: Both sides cite evidence—in fact, they both cite the same letter from Cook—but that’s precisely the problem. The stock market is not a tightly controlled lab experiment in which one can draw conclusions from the data. Far from it. Yes, there’s a lot of data, but much of it is contradictory and incomplete, so it shouldn’t be viewed as conclusive. Market analysts sound like they’re stating facts, when in fact they are really just stating opinions. That’s why I wouldn’t get too worried, or excited, in response to anything you read or hear about the market or any individual stock.
According to Philip Tetlock, an authority on forecasting, there’s a negative correlation between an analyst’s reputation and his or her forecasting accuracy. All that time being interviewed on TV, it turns out, leads to overconfidence. The upshot: To the extent that you should ignore market analysts, you should be especially leery of those who are well known.
Adam M. Grossman’s previous blogs include Intuitively Wrong, Paper Tigers and What Matters Most. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.
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Adam – Thank you for this insightful commentary. I find it very helpful, as I do the response of Rquinn. I like to listen in on conversations between smart people. – Dave