When you can start ignoring an investment argument

Economics and finance are full of debates. If you are looking for settled truth, go look somewhere else. I trained as a mathematician and physicist. In mathematics, there is plenty of absolute truth (though not always as shown for example by Gödel’s Incompleteness Theorems) and in physics, an experimental result is only accepted as “truth” if it is five standard deviations away from zero, which can lead to some strange press reports like this one. In economics and finance, it is a success if we get a result that is two standard deviations away from zero.

Thus, most of the time, we argue about one effect vs. another trying to predict how markets or the economy is going to evolve in the face of multiple influences. This is what punditry is built on. If there is no objective truth available, all kinds of people can make all kinds of wild claims about stock markets, inflation, and other stuff. And because everybody is making different claims, the key to success for pundits is to grab the attention of clients with outrageous and aggressive predictions and claims. This is how punditry on television works and this is how sell-side research works. 

Meanwhile, the people who are making the good forecasts tend to be the ones that are more middle of the road and shy away from the extremes, but they are drowned out by the loudmouths. I have published my 10 rules for forecasting several times now and if you read them, you will find that they are a call to moderation and middle-of-the-road forecasts, not aggressive or extreme forecasts. Why? Because the extremes are called “extremes” because they rarely happen.

But enough self-pity. I write these posts to help separate the signal from the noise and I thought, I share with you my three signs that someone is leaving sound arguments behind. If you read the views of an “expert” who uses these three techniques, you should immediately become skeptical and start wondering if you should take the argument seriously. 

Nevertheless

The word nevertheless is one of the clearest signals that someone leaves evidence and data behind and ventures into the realm of beliefs and ideology. I have heard people argue that after the financial crisis of 2008 central banks engaged in massive quantitative easing and that back then this didn’t lead to inflation. “Nevertheless”, the amount of stimulus unleashed in 2020 is so much larger than twelve years ago, that this time it is going to trigger inflation. 

I am paraphrasing here but the argument is essentially that the data we have from the one episode in the past where we tried QE didn’t show the desired outcome, so now that we do more of the same, the outcome will be different. Maybe it will, maybe it won’t. But clearly, this person has no evidence or data to back up the view…

We only have one observation

This brings me to the second rhetoric sledgehammer. The argument that past data is not predictive of the future. 

Pundits tend to be perfectly happy to provide charts and analysis using historic data and episodes that confirm their views. Yet, when it comes to episodes that contradict them, they sometimes argue that “it is only based on one observation in the past or one time series of stock market returns since year x.” The argument then often continues along the lines that because we have only one time series and one history, things might have well turned out differently in which case things would have been like the expert says they will.

Maybe they would, maybe they wouldn’t. But by saying that the only data we have is not relevant today, you are essentially saying that we should abandon data analysis altogether and rest our decisions on theories and wishful thinking alone. Feel free to do that but don’t come to me if the theory turns out to be flawed and your investments poor.

The slippery slope

This rhetorical fallacy is so widespread and so old that it has its own dictionary entry. It is one of the most commonly used techniques in politics, investments, and social matters to scare people into adopting a desired point of view. 

For example, people may argue that “governments have too much debt and if we don’t reign in deficits with severe austerity measures, the deficits will create inflation that will run out of control until it has ruined us all.”

Maybe it will, maybe it won’t, but the argument is making way too many leaps here. First, there is little evidence that high deficits create inflation in developed markets. Then, there is the assumption that central banks don’t exist to fight inflation through higher interest rates. Or the assumption is made that once inflation has increased above a certain level it is hard or even impossible to catch (no it isn’t). In any case, to follow this argument implicitly makes so many assumptions about how the world works that it effectively boils down to wishful thinking or investing based on theory without checking the data. So, feel free to follow these slippery slope arguments but don’t complain if you end up on the wrong side of the trade.