July 25, 2013 Update

DJIA:15,542 S&P 500:1,686 NASDAQ:3,580 Gold:$1,320 Oil:$105.20 EURO:$1.32 YEN:99.95

When the Numbers Lied

Human beings have a relationship with their pasts that they cannot seem to divorce. Even the most intensive psychotherapies often fail to erase the memories people wish they could not remember.  Because of the emotional connection that lingers between man and his past, investors have constructed metrics that attempt to impartially determine an asset’s financial health. Once determined, these results are entered in a statistical program that then spits out the calculated forecast of an asset’s behavior. These projections apparently represent financial forecasts, which are then used by investors to help them determine the risks and benefits of a position. Most of the time, people will not invest without these projections because investors view the system as the most accurate way to forecast the future (since it does not account for human bias). For better or worse, I am not one of these investors. Before the bubble burst in the housing market, a financial engineer used a complex calculation to determine the probably of default correlation for debt instruments. It’s creator, David Li, won a Nobel Prize for his concoction of a risk metric. Investors misperceived his inference as fact and bought into the bubble, despite the rumors that the market was overbought. We all know what happened next. The Gaussian Copula formula was an inaccurate way to forecast the future and is still largely blamed for the entire credit crisis of 2008. The moral of the story is that tail risk is impossible to predict. There is no historical evidence that could have possibly foreseen the bubble bursting in 2008. In fact, all the financial projections portrayed continued growth and prosperity. There is no metric or projection that accurately calculates and foresees the probability of a black swan because human psychology is not included in the calculation. Market behavior is derived from investor sentiment and belief. Yet, humans would rather rely on the thoughtless and unemotional numbers and ignore their instincts and gut feelings. To put it simply, humans do not trust themselves. We do not trust ourselves. I do not think numbers alone are creating the narratives investors are searching for because the markets are more psychological than they are mathematical. Technical analysis remains one of the most accurate forecasting methods, since it depicts human behavior, but I still think a better approach exists. The ideal way to predict market movements would be a system that incorporated human psychology, investor attitudes, and historical trends. The relationship linking humans to their pasts is indelible and absolutely impacts the choices they make. Emotional thinking can be an evil itself, but allowing the numbers that have no human connection to predict investor behavior has failed, and is doomed to fail again. 

Domestic News

• Market Update Futures are up ahead of durable goods and a fresh round of corporate earnings. 
• Durable-goods orders will be released at 8:30, and are expected to rise 2.3% in June driven by robust demand for commercial airliners. 
• Jobless claims will also be released at 8:30, and are expected to rise to 342,000 from 334,000 in the second week of July driven by season shirts in the auto industry. 

International Updates

Asia

• Market Update Markets fell as a result of worse-than-expected corporate earnings.
• China has increase its budget for railway spending to 690B yuan ($112B) as the government looks to accelerate construction. Building will continue to artificially inflate the country’s GDP as the government scrambles to boost the numbers to hide the economic slowdown.  

Europe

• Market Update Market reacted negatively to downbeat earnings from U.K. firms despite upbeat economic indicators. 
• Spanish unemployment unexpectedly fell to 26.26% from 27.16%, the first decline in over two years. While 5.98mm remain unemployed (half of which have been jobless for over a year), a strong tourism season is creating jobs.
• Germany’s Ifo index of business confidence rose higher than expected and reached 106.2 for July vs. June’s 105.9; depicting business growth in the region. 

Corporate

• GlaxoSmithKline (GSK) has agreed to pay $229M to settle lawsuits with eight states that blamed the company for misrepresenting risks involved for the diabetes treatment Avandia, which apparently increases the chances of heart disease and strokes.