No, this week’s commentary isn’t going to be a Tony Robbins-esque speech about not settling for mediocrity. Rather, I’m going to focus on the fact that if you focus on average, you get average results. Most investors, media gurus and anyone else involved in the markets are consumed by average.
Every single fundamental data point that is released, domestically and abroad, is released with a headline number and how that number stacks up against “expectations.”
Expectations is just another word for consensus and at its core, a consensus is just the average of all the participants views. For instance, last week, US retail sales for August was reported. Retail sales grew 0.6% month-over-month from July. This compared to the consensus of 83 economists, or expectations, of a +0.6% month-over-month growth.
What does this tell us?
It tells us that retail sales matched the expectations of 83 economists.
Does that give us an edge? How do we know that the economists numbers are reliable? What you never hear is what the range of the economists estimates is. For last week’s retail sales number, the range of estimates from those same 83 economists was from 0.1% all the way up to 1.2% month-over-month growth.
Wouldn’t it be far more valuable to understand how one economist reached an estimate of 0.1% or why another one believes that retail sales would crush it and grow 1.2% month over month? Rather than the 81 other economists whose estimates ranged from 0.55% to 0.65%?
When it comes to fundamental numbers are far more interested in what happens at the margin, rather than what a bunch of economists “estimate.” Last week’s 0.6% was an improvement over July’s 0.3% month over month growth rate. This tells us that growth is accelerating higher.
More important, this acceleration broke a streak of four consecutive months where retail sales growth was declining, on a month over month basis. In addition, the year over year growth rate for August’s retail sales was 5%, which was also a month over month acceleration from July’s 4.2% yearly growth rate.
That yearly growth rate was also the highest in over a year. It's far more valuable, as an allocator of capital, to understand the context of a fundamental data point rather than whether that data point met, exceeded or missed the expectations of a room full of economists. If you focus on the average, you’ll get average.
Investors’ infatuation with averages is not just a phenomenon found in fundamental data, it’s also prevalent in the analysis of technical data.
Not a day goes by that you don’t hear about this market trading above its 100-day moving average or that market crossing below its 50-day moving average.
The real question is: Do moving averages give you an edge? Do they tell you something valuable about a particular market? No, moving averages provide no useful edge for trading.
There is absolutely no data out there that suggests moving averages provide traders with a reliable predictor of future price movement. The only thing a moving average can do, is very quickly tell you what the trend of a particular market is over the particular time frame of the moving average.
But moving averages aren’t the only aspect of technical data that investors misuse. Investors focus on average returns, average volume and indices.
An index is nothing more than the average performance of all the index's components. Lets walk through a brief example to clarify this point. The average performance of the S&P 500 index, via the ETF proxy SPY, since July 24, when SPY made a new all time high, is 0.05%, the average daily volume has been 86 million shares and the average weekly volume over that time has been 426 million shares.
Does this information help you evaluate whether or not to allocate capital to SPY, or US equities in general? You know the daily and weekly volume and you know that SPY is essentially unchanged over the last 2 calendar months or 36 trading days.
There is no edge in this average information.
This is not to say that the technical data of the SPY over the last 36 trading days can’t provide us with an edge moving forward, quite the opposite. During those 36 trading days, SPY declined 3.8% over the first 11 days with daily volume of 112 million. The SPY rallied 4.3 % over the next 25 days with daily volume of 75 million as of Friday’s close.
We now have much more information to work with than what the averages alone provided. We see that since making a new all time high on July 24 there has been a struggle between bulls and bears. We also see that the initial decline occurred on volume that was 50% higher than the volume of the subsequent rally back to the aforementioned all time high.
Now, this information by itself doesn’t tell us how to trade SPY. But this more detailed data, helps us build out our picture of the US equity market much more clearly than just averages alone.
A Week To Remember
If you focused on last week’s averages, it would appear that it was just another ho-hum week in the markets sandwiched between and exciting week where the ECB unexpectedly cut rates and this week’s FOMC meeting. You’d be wrong.
Last week could very well be the beginning of a regime shift in global financial markets and there wasn’t one significant fundamental data point or central bank meeting.
If you look at SPY’s return last week, a decline of 98 basis points isn’t really a price move worth noting. Especially when you put in the context of the 5% rally over the preceding 3 weeks.
But something quite important occurred last week with respect to US growth expectations. I periodically update what markets are saying about US growth expectations. I use a two proprietary indices, which I believe give me an edge in trading US based assets.
One indicator typically outperforms when US growth is accelerating and the other performs well when US growth is slowing. In fact, I did that update a month ago, in the August 18 issue of TWR.
At that time, US Slow Growth Assets were outperforming US High Growth Assets by 1006 basis points, year to date. And Slow Growth Assets were outperforming the broader US equity market, SPY, by 590 basis points.
As of Friday’s close, US Slow Growth Assets are outperforming US High Growth Assets by 560 basis points, year to date. And Slow Growth Assets are outperforming the broader US equity market, SPY, by 70 basis points.
That means that in the last month, Slow Growth assets have given up half of their outperformance of High Growth assets and all of the outperformance over the broader market. This tells us growth expectations for the US have been shifting.
So, what’s so special about last week? Most of the spread contraction between slow-growth assets, high-growth assets and SPY, occurred last week, with no new critical information of any kind. Remember, what matters most in markets, occurs at the margin.
In addition to a massive spread contraction of more than 300 basis points in a week, my US Slow Growth index had its largest weekly decline since June 2013. Why is this important? Because the large weekly loss occurred just before a huge acceleration in US GDP growth in Q3 2013 and it marked the beginning of a huge outperformance of US High Growth assets over both slow growth assets and the broader market, SPY.
From the end of the weekly decline on June 21, 2013 through the end of the year, US High Growth assets returned 20.2%, US Slow Growth assets declined 3.3% and the SPY returned 16.5%. High Growth outperformed slow growth by 2,350 basis points and the SPY by 370 basis points. That’s a significant edge and significant outperformance, especially considering it's over just six months.
Be Fearful of Being Average
I hope you will resist the urge to be satisfied with only average information. Most investors are satisfied with average information and most investors either lose money or sorely underperform their potential.
A true edge and subsequent ability to outperform other investors over long periods of time comes from focusing on the outliers, the rare events or circumstances, not the average, or everyday occurrences. There is far more valuable information in the rare than in the common.