As financial market participants, to trade successfully, we need to be mindfully aware of statistics because they can be used by individuals, companies, and countries to sell a particular narrative that might deviate from the truth.
Those tabulating the statistics have political reasons to change, distort, and/or mask data to serve their own agenda.
For example, unemployment rates are used as a general parameter of the health of an economy. Consumption makes up approximately 70% of the most developed economies and maintaining this is predicated on people having jobs. If unemployment is low, output should be correspondingly high. And once a point of “full employment” is reached – i.e., there are a lack of substitute workers in the economy – workers have the power to bargain for higher wages and salaries should therefore increase.
Corporations will tend to pass off these higher wages through price hikes on goods and services. Thus, looking at unemployment figures is a common approach for central bankers and investors to determine whether inflation is on the rise.
However, unemployment rates are exceptionally distorted metrics and are largely formulated in a way to make political regimes look good.
This specifics of the unemployment rate vary from country to country depending on how they define it, but the headline unemployment figure is a bureaucratic contrivance for several reasons: (i) it ignores people who are discouraged and no longer looking for work; (ii) it counts people who are working for as little as one hour per week; and (iii) it ignores the quality of the employment and how well labour is utilised in a market.
All these points are very important considerations in determining how much slack there genuinely is in the labour market.
The current reading for US headline unemployment is about 4% currently. This provides the insinuation that 96% of workers are happily employed, but this is very far from the case.
Civilian labour force participation is less than 63% and many workers are far from being optimally utilised.
This 4% figure is derived from a large swath of potential workers being excluded entirely and including workers who are only marginally involved or harnessed in the labour market.
Government Financial Bodies Mistruths
Governments also have the incentive to over-report output (GDP) and under-report inflation.
Inflation no long represents the cost-of-living index that it once was intended to do.
Over time, the calculation has changed reducing the weightings of some items and increasing the weightings towards others, while excluding other items.
There can be valid reasons for doing this – namely, consumers may not purchase as much of one item as they did in the past, thus shifts in certain weightings can be reasonable and appropriate. And certain volatile items like energy and food can be excluded to help better approximate the ongoing trend in inflation.
But it’s nonetheless important to avoid making uninformed decisions based on flawed statistics.
Misinterpreting inflation readings has implications for mispricing in bond yields and the discount rates that are used to calculate the present value of the cash flows of equities. In turn, this can lead to distortions in asset prices.
The value of a business – and therefore its stock price – is a function of how much cash you take from it over its life discounted back to the present. If growth, which feeds into earnings, is overestimated and inflation, which feeds into the rate at which cash flows are discounted back to the present, is underestimated, this means financial assets whose intrinsic value is dependent on these calculations will be overvalued.
Moreover, many government programmes are tied to cost-of-living adjustments (e.g., social security) as are some financial assets (e.g., inflation-linked sovereign bonds). Skewing this calculation downward can help governments save money.
China is also quite loose with its statistical reporting as it grows as a world economic power. For example, its current account surplus is underestimated by approximately $100 billion because its services deficit is overestimated. On top of that, in 2014 it changed how it calculated its travel outflows, which overestimates its tourism deficit.
Why might it do this? China has been criticised for years on an international level for having a high current account surplus by engaging in practices to boost areas of its economy that the country’s growth was most dependent on, such as depreciating its currency.
When a country depreciates its currency, it makes its goods cheaper relative to other currencies, increasing the demand for them. Lowering this deficit statistically by tampering with the tabulation methods can help assuage any censure it might draw from other countries.
In terms of financial market considerations on a macroeconomic level, knowing the details of a country’s balance of payments is vital because it has important implications for its currency. In the long-run, trade surpluses/deficits are offset by currency moves.
Countries sporting some combination of fiscal and current account deficits must see their currencies weaken to fill the gap while those with surpluses will see them strengthen, holding all else equal. (Note that this is not relevant in the short-run.)
Countries do the same type of things with their accounting that public companies do to paint themselves in the best possible light.
COUNTRIES ARE IN MANY REGARDS WORSE BECAUSE OF THE LACK OF EXTERNAL AUDITING AND OTHER INDEPENDENT OVERSIGHT MEASURES THAT PUBLIC COMPANIES ARE SUBJECT TO.
This means much of the work we engage in has to be forensic. Markets where we do not have an information or analytical edge need to be avoided.
For example, how can we know a country is preparing for weakness in its own currency?
You can look at behaviour occurring in government financial accounts or other quasi-government entities such as state-owned enterprises that are traditionally off the radar of most investors.
Are they prepaying debt that is not denominated in their domestic currency?
Are they hedging foreign currency debt?
When a currency depreciates, this makes foreign debt harder to service in relative terms. These are all red flags that should set off one’s alarm that a currency devaluation may be in the works and position accordingly.
Gathering statistical information and properly analysing it is important to better understand the world and make informed decisions. However, the source of this data and the way it is formulated matters. Performing quantitative analysis to some degree is important to doing well in the markets.
But blindly following purported facts or statistics mentioned in the media, by politicians, by government bodies, by corporations, or by any party with a particular vested interest that is self-serving needs to be vetted.
Usually numbers are not thrown around because they are true, false, or one or the other depending on context, but to sell a particular agenda.
It is largely not a “game” of what’s true and what’s false; it’s a “game” of marketing. This inherently lends numbers and ostensible facts to purposeful spin-doctoring.
To understand behaviour, one has to understand the incentives governing it.
The media follows the same business model as “reality TV”.
Its principal objective is not to inform. Like all television and many other forms of media, they are a conduit for delivering advertising.
The ultimate goal is to gain viewership/readership, which is inherently a very different type of goal than being an objective arbiter and purveyor of the truth.
Most TV programmes accomplish this by entertaining; the media largely does this by invigorating politically charged topics. Its constitutional freedom in most democracies leads to a lot of unrestrained power and thus inherently poor quality control; in more authoritarian regimes, the media is largely a state-led propaganda platform.
Naturally, there will be a bevy of half-truths, lies, selective omission of key information, simplification of complex issues, advertisement of a particular cause, preying on emotion, partisan attacks, and targeting of an intended audience. And much of it, including the statistics used by government bodies, is not merely careless reporting, it is meticulously crafted.
Accordingly, a healthy degree of scepticism is always warranted.
In our case, we should choose to unearth the facts for ourselves through careful analysis and calculations in the relevant markets we participate in and The Macro Trend provides a platform for this.
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