Investors strive to identify market directions using empirical data - and by examining trends in shopping centres, car parks and restaurants. Vanessa Drucker reports on the value of anecdotal evidence.
On October 1929, Joseph P Kennedy was on his way to Wall Street to see his broker at JP Morgan. When he stopped to have his shoes polished, the shoeshine boy allegedly recommended he invest in RCA and US Steels, because he had heard they were “hot”. Kennedy parlayed that tip into a decision to sell all his stocks, and thereby sidestepped the market crash that occurred a week later.
That famous Wall Street lore is often quoted for the value of anecdotal evidence, and even more, the importance of how it is used. (If Kennedy had instead bought boatloads of RCA, and squandered his fortune, his son might never have become president.) The usefulness of both anecdotal observations, derived from personal experiences, and official data depend on how they are applied. In March 2001, when American central bankers convened, the Federal Reserve Bank of Dallas reported “robust Valentine’s Day spending, including healthy sales of singing gorillas”. In retrospect, who could have guessed that the musical apes signaled a Nasdaq market top. (article continues below)
Informal data points work best alongside the official statistics garnered by the government and the investment industry, which are based on larger samplings and somewhat more scientific methodologies. When used in conjunction with more formal numbers, anecdotal evidence can confirm trends or identify emerging ones. It can even provide a warning at major inflection points, like the shoeshine boy’s, that particular markets may be overdone. “When the barber tells you he is trading tech stocks or flipping houses, it is a sign things may have overheated,” says Dan Moisand of Moisand Fitzgerald Tamayo in Melbourne, Florida and former president and chairman of the Financial Planning Association. “I see that, with all the gold-buying shops in strip malls, and gold parties like Tupperware, which have been popping up.”
Tom Wilson of Brinker Capital in Berwyn, Pennsylvania, likewise notes the glut of television advertisements for buying gold.
In all industries, every smart business monitors public demand and competition. Investment management should be no exception. Anecdotal research gained additional respectability in the 1990s with the publication of books like One Up On Wall Street, by Peter Lynch, who then ran Fidelity’s stellar Magellan fund. Lynch encouraged his amateur investor readers to comb shopping malls for products poised to become sales standouts. “It’s an old adage to buy the companies you know and follow what you see in your neighbourhood,” points out Kelly Campbell, a wealth manager in Fairfax, Virginia, who uses conversations with his barber as a quick reality check.
“The key to using anecdotal evidence is to keep its limitations in mind, just as with statistics,” Levy suggests. “Taxi wait times and restaurant reservation availability are great indicators of the local economy in a city like New York, but one has to make sure there are no special factors – increases in gypsy [unlicensed] cab drivers, major conventions affecting tourism in certain neighbourhoods, and so forth.”
The human mind is prey to a host of cognitive biases and heuristics, extensively docu- mented by Daniel Kahneman and Amos Tversky. These shortcuts are helpful for processing information, but can also distort the weight of perceptions. Some of the most common ones apply to anecdotal conclusions. Especially relevant traps would include the “anchoring effect”, or tendency to rely on one trait or piece of information, and an “availability” heuristic, which propels us toward what is most accessible in memory, and likely to be vivid or emotionally charged examples. A “clustering” illusion encourages people to grasp at patterns where none exist, and a “primacy” effect gives more prominence to initial than to subsequent events.
One of the challenges of analysing empirical data is that of weeding out confounding factors. As a simple case, take the fluctuating price of oil, which may have a disproportionate impact on travel or vehicle use. Even during booming times, a run up in energy costs has an immediate effect on daily habits. John Sawyer, the chief investment officer at Compass Bank in Houston, explains that signs like crowded planes or lines for security at airports can be misleading, since the carriers have become so skillful at yield management. He recalls, “You simply don’t find empty planes, at least on major routes, as you did prior to 2000.”
”Taxi wait times and restaurant reservation availability are great indicators of the local economy in a city like New York, but one has to make sure there are no special factors”
On the other hand, he still canvasses the parking lots at airports, because “the ease or difficulty of finding a parking space is a dead give-away for overall flight [and thus business] activity”.
Even after it is stripped of mental biases, confounding factors and local anomalies, correct economic analysis may not lead to investment outperformance. “Markets are so contrarian that people who try to game the system often draw exactly the wrong conclusion,” Berman warns.
Dave Taggart, who formerly worked at Maverick Trading, agrees: “Having worked in a retail brokerage I am well aware that the crowd is almost always wrong at turning points. We see this with put/call ratios and other easily quantified sentiment indicators.
“My first and best indicator is actually my Mom, the quintessential wrong way investor. Every time she calls me out of nowhere, worried about the market, we hit a bottom, and every time she calls wanting me to buy her more and riskier stocks, the market tops.”