Maybe I should be using my economics degree as a tissue.
Sounds harsh, I know, but can you blame me? Most schools of economics completely missed the oncoming financial freight train that smashed into the United States. As for the schools that claim to have been right on top of the situation, they had largely been calling for it way too far in advance. Can you imagine if a weather forecaster called for a Category 5 hurricane every day for two years and then took credit when one finally hit?
But for all the holes we can blow through this somewhat smeared social science, the assumption of rationality may be one of the biggest. In a recent FT.com article, University of Leuven professor Paul De Grauwe took macroeconomics to task in general, but highlighted economic models' assumption that we all act rationally as a core problem with the discipline.
Need I mention Gary Busey?
Busey is fun to mention because he's said some rather irrational things -- "When you get lost in your imaginatory vagueness your foresight will become a nimble vagrant." -- but it's really impossible for any of us to claim consistent rationality.
Whether we like it or not, our brains are wired in such a way that our actions can often stray very far from rationality. And while economists like to believe that temporary irrationality in some "agents" in the economy is balanced out by other agents, unfortunate behaviors like the bandwagon effect can blow that assumption way out of the water. And for those economists with their heads still in the sand, I'd ask where the rationality was when it came to AIG (NYSE: AIG ) , Citigroup (NYSE: C ) , or Lehman Brothers.
And while I'd love to go on ripping apart rationality, author Jonah Lehrer actually did a much better job than I ever could in this recent episode of "Motley Fool Conversations."
Eggheads with models
No, I don't mean rich nerds dating Victoria's Secret women, I'm talking about smart folks trying to get too cute with financial and economic forecasting models.
At this point I think many of us have come to the conclusion that complex mathematical models created by financial eggheads -- whether at the yet-successful Goldman Sachs (NYSE: GS ) or the disastrous Bear Stearns -- helped bring us to the financial brink.
While there are a host of problems we can point to with these models -- including inspiring overconfidence -- this issue of rationality is a huge tripping point. Many of these models relied directly on some assumption of rational investors, but pretty much all of them leaned on economic forecasts that came from models that used rationality as a key starting assumption.
As I learned from my days as a computer programmer -- garbage in, garbage out. Relying on this nonexistent rationality makes the output of most economic models about as useful as a winter parka at midday in the Kalahari Desert.
Can we divorce economics?
Investors will have a tough time -- and by "tough time," I mean "impossible time" -- avoiding the impact of the economy on their investments. After all, Amazon.com (Nasdaq: AMZN ) will be able to sell more books, DVDs, and Kindles, and Dell (Nasdaq: DELL ) will sell more computers when the economy is roaring along.
But even if we can't sidestep economic outcomes, we can expend fewer braincycles dizzying ourselves with the myriad contradicting economic predictions. Peter Lynch, one of the greatest investors to have run major money, once said "I spend about 15 minutes a year on economic analysis."
Skip that, do this
There's no need for a complex economic model to learn more about the management team at Whole Foods (Nasdaq: WFMI ) , and you don't need to run any multivariate regressions to learn more about Activision Blizzard's (Nasdaq: ATVI ) strategy. (You can find it in its second-quarter slide presentation and its most recent annual report).
And while all companies are beholden to the economy to some extent, having the very best companies in your portfolio will give you the best chance for long-term outperformance even without correctly reading the short-term economic tea leaves.
Have some thoughts (or complaints!) of your own about macroeconomics? Scroll down to the comments section and let me know what you think.
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