- We humans assign undue weight to the circumstances and storylines closest to us.
- This phenomenon is evident in our obsession with so-called "economic bellwethers."
- Don't divine broad earnings results by a few reports. Some firms are bellwethers by tradition only, and in no single company can we predict the fate of the whole economy.
(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)
The world is a big, complicated place. Trying to make sense of it all is the ever-curious human mind, awash with dreams and philosophies, hypotheses and lint. (Let's face it, there's some fluff in even the most brilliant mind.) But because we're sitting on the ground floor, our perspective is limited. Because we see out of only one set of eyes, our experience is narrow.
Given no alternative, we extend our narrow experience to the world at large—all it takes are a few local troubles to support nationwide turmoil. If our brother-in-law Scott and his cross-town rival Bruce are having tough times keeping their local auto shops afloat, we tend to assume the whole auto industry must also be in trouble—but it's really never so simple. A whole city of mechanics could be in trouble, but economically it wouldn't matter if two cities 600 miles away (outside our realm of everyday experience) are booming.
Further, folks prefer storylines to simple facts and statistics. Many journalists are well aware of this human tendency. They've found it's more compelling to follow the story of one family their readers can identify with than to cover a minute change in an impassive economic index.
Unsold Homes Tie Down Would-Be Transplants
By Louis Uchitelle, The New York Times
These human tendencies are often exhibited when investors analyze publicly traded companies. Earnings season hits and the storylines abound—company XYZ reports the quarter's profits fell because people bought fewer widgets or energy costs were up. Nowhere is this phenomenon more evident than in our obsession with so-called "economic bellwethers."
Bellwethers are single companies thought to represent entire business segments, and they often make headlines around earnings season. Supporting this quarter's economic storylines, JC Penney and UPS embodied consumer spending, Alcoa exemplified materials production and Apple was everything tech.
Apple's 2% Slip Fuels Tech-Sector Anxiety
By Geoffrey Rogow, The Wall Street Journal
Penney's Grim Forecast Sounds Warning Bell
By Staff, MarketWatch
These companies often hold sway over the collective simply by tradition. JC Penney for instance, with its tiny $9 billion market cap, might have been a more appropriate indicator during the era of Miracle on 34th Street, when giant department stores were the American consumer's venue of choice. But even then Penney's was inferior to Macy's and Gimbel's, and today Wal-Mart dwarfs it with a whopping $214 billion market cap. Similarly, compare Alcoa's $30 billion market cap to Rio Tinto's $171 billion. And still neither Rio Tinto nor Wal-Mart represents the whole market.
Bigger bellwethers like UPS or Apple might make more sensible economic indicators, but they participate in highly competitive industries. Competition makes it difficult to separate a loss in one company's market share from a broad economic trend. And for all these so-called bellwethers, it's important to remember profits, earnings and sales don't solely depend on the consumer buying more widgets or low commodity prices—these numbers also depend heavily on effective and innovative management.
The modern marketplace is extensive, and even the biggest companies don't represent the whole. Take care when assigning too much weight to just one storyline or set of local circumstances.