In 2005, the comedian Stephen Colbert popularized the word “truthiness.” This term, if you’re not familiar with it, refers to something which seems like it should be true but isn’t actually supported by evidence.
Are stock market pundits guilty of truthiness? To answer this question, let’s look at an event that occurred this week.
First, some background: In the life of an investment analyst, there is a rare but dreaded phenomenon known as a “profit warning.” This occurs when a company can tell, based on preliminary numbers, that its quarterly results are going to be truly dismal and far below expectations. When companies find themselves in this uncomfortable situation, they move quickly to disclose what they know, rather than waiting and surprising everyone on the regularly scheduled quarterly conference call.
That is what happened to Apple this week, for the first time in sixteen years. In a letter to shareholders Wednesday, CEO Tim Cook warned that iPhone sales had been weak and that revenue would be down $4 billion from last year. The stock price reaction was swift and harsh: down 10% the next day.
In response to this event, market pundits immediately took to TV and radio with these opposing viewpoints:
Apple detractors were quick to point out that, “trees don’t grow to the sky.” In other words, companies can’t just keep growing forever. Just as IBM and Xerox and BlackBerry have all seen their stars fade, it is now Apple’s turn. To support their view, detractors point out that iPhone sales have plateaued and that Apple hasn’t delivered any truly new products in years. To further support their view, detractors pointed to Tim Cook’s letter, in which he seemed to be grasping at straws, blaming slow iPhone sales on things like the availability of inexpensive battery replacements.
Apple supporters, on the other hand, took the position that “this too shall pass.” In their view, the stock market is simply overreacting; they see Apple stock as a bargain at these lower prices. After all, Apple is still the smartphone leader in the United States. Last year, they sold an astonishing 217 million phones. To bolster their view, Apple supporters point to Tim Cook’s letter, which noted a number of non-Apple-specific issues, including exchange rates and trade tensions with China. In other words, Apple is just fine. Sure, it wasn’t a great quarter, but Apple was simply the victim of factors beyond its control.
What should you conclude from these contradictory viewpoints? Is one side or the other guilty of truthiness? When you hear these types of things on TV or see them quoted in the paper, who should you believe?
My view is that you should ignore them both—but not because either is guilty of truthiness. Market analysts are all trained to rely on data. You can see that in the above examples: Both sides cite evidence—in fact, they both cite the same letter from Tim Cook—but that’s precisely the problem. The stock market is not like a tightly controlled lab experiment in which one can draw conclusions from the data. Far from it. Yes, there’s lots of data, but much of it is contradictory and incomplete. As a result, none of it should be viewed as conclusive. The result: Market analysts sound like they are stating facts, when in fact they are really just stating opinions. That’s why I wouldn’t get too worried, or excited, in response to anything you read or hear about the market or any individual stock.
In addition, according to Philip Tetlock, an authority on the topic of forecasting, it turns out that there is a negative correlation between an analyst’s reputation and their forecasting accuracy. All that time being interviewed on TV, it turns out, leads to overconfidence. So, to the extent that you should ignore market analysts, you especially want to ignore the ones who are most well known.