IGNORE THE FED FACTOID

And for good reason!

If you want to use history as a guide, care is required. I thought this was pretty obvious until my morning watching of CNBC in Davos (it doesn't seem the same without Maria) showed Andrew Ross Sorkin interviewing Kenneth Rogoff. This seemed interesting, so I turned off the mute button and backed up the TIVO. Here was someone who could really grill Rogoff about the research findings that are now the source of so much controversy.

What a disappointment! There were no hard-hitting questions. Even worse, Sorkin uncritically accepted as fact a silly bearish idea about the Fed. CNBC has trimmed the interview to exclude that portion, but I have it on TIVO. Sorkin says that whenever there is a new Fed Chair, the market corrects within the next six months.

Let us examine that Factoid.

Background

A couple of weeks ago a Famous Bearish Pundit noted on Twitter than when there was a change in the Fed Chair, the market usually declined. Someone asked the FBP when he expected the correction. He replied that it was not a prediction, it was a fact.

Well!

There is a lot of buzz about not doing predictions, but most of the history cited is offered with that in mind. The basic notion is that history will repeat, and that these simple bivariate relationships are relevant to your trading or investing.

FBP moved on, but here is a source that took up the argument.

The average maximum drawdown in stocks during the first six months of a new Fed Chairman has been 16%. This is consistent with other indicators that suggest an elevated risk of correction as we move through 2014.

Analyzing a Factoid – First Cut

Whenever you are presented with a proposition like this, the insightful investor should be seeking a basis for comparison. Suppose for example, that the maximum drawdown for stocks is ALWAYS 16% over the next six months. In my own work, I always warn investors that this level of change is a normal fluctuation, having nothing to do with the fundamentals of the market. What you really need is a 2 by 2 table, with Fed leadership change and No Fed leadership change on the horizontal axis, traditionally reserved for the independent variable. Then we can see if there is a real difference in results. Should it be average result? Maximum drawdown? What time period?

You can be sure that your pundit will pick the case that favors his viewpoint.

Second Cut

The insightful investor digs a little deeper. I always look at the data. Statistical experts regard this as getting your hands dirtyJ Instead of blindly accepting a statement about changes in the Fed Chair, you ask what data might be relevant. Let us start by looking at the history of changes,from Wikipedia.

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