How to use economic indicators to become a better investor (transcript)

This is a transcript from an interview with Robert Wright, co-author of a new book, The WSJ Guide to the 50 Economic Indicators That Really Matter: From Big Macs to “Zombie Banks,” the Indicators Smart Investors Watch to Beat the Market. You can listen to the program below or go here.  Check out our interview archives. Subscribe to receive new interviews on iTunes.

The following transcript was paid for at Speechpad.

Announcer: Live from the Internet, it’s Tradestreaming Radio with your host, Tradestreaming.com’s own, Zack Miller.

Zack: Hey, this is Zack Miller. Welcome to Tradestreaming Radio where we help investors make better decisions with tools, tips, and technology. We speak to some of the smartest and most creative people out there working in this space and hope to illuminate some of these ideas to you.

Today’s guest is a co-author of the new book, The WSJ Guide to the 50 Economic Indicators That Really Matter: From Big Macs to “Zombie Banks,” the Indicators Smart Investors Watch to Beat the Market It was co-written by Simon Constable, a journalist at the Wall Street Journal, and Robert Wright.

Robert Wright will be our guest on today’s show. He is the Nef Family Chair of Political Economy at the Augustana College in South Dakota. Wright is an accomplished author. He has two pages worth of books that he’s published on Amazon. He teaches monetary history. He teaches business. He teaches about price discrimination. What I think makes Wright and this book so valuable for people is that it combines detailed scholarship, really sort of drilling down into numbers, fact-based investing. I’m seeing how some of the leading indicators, some economic data and business data that we read about every day in the paper, how those really impact investing, testing them, going as far as seeing whether these data actually help investors and how profitable they may be as investing strategies. But he’s also a good writer. He’s a self-described cynic, along with Simon Constable, and the book has a very good readability.

Some of the things you might learn about in this podcast, so successful investing means making and keeping above market returns at each stage of the business cycle, and this book very much focuses on trying to determine where we are on the map of the business cycle by looking at certain criteria and then figuring out how to invest based upon that location. Investors must correctly forecast the business cycle before they can know which types of specific investments are likely to generate superior returns.

Wright recommends that looking at investing not as a one-off event. It’s a learning process. This is something I talk about in Tradestream all the time. It’s a lifetime commitment to understanding the economy. Forecasting is more art than science. We know this as investors, and it’s good to have rules-based investing, but we know that no rule is going to be right 100%, and our capacity to accurately predict stems from a combination of historical data and a model that correctly identifies causal agents rather than mere statistical correlations.

There are 50 indicators in this book. Some are well known, some are less well known. It’s a good book. It doesn’t cost a whole lot. It’s like $9.99, whether you buy it in mass market paperback or you buy it for the Kindle, which is where I read. It’s useful. It’s definitely important for business cycle investing. It should deserve an important place on your shelf.

Come back to the blog. Please give us any feedback you have on this podcast. If you’re listening to us on iTunes, please, give us a ranking and a review. We’ll definitely appreciate that. We want to get the word out about Tradestreaming Radio. Also, on the blog, I will have a transcript of this interview with Robert Wright. I’ll have some more links about Robert Wright. We can find out some more things about him, and we’ll jump into the conversation now.

I started our conversation asking about Wright’s decision to come out with a freemium model for his own textbooks for his courses in college.

Hear the whole program

How to use economic indicators to become a better investor by tradestreaming

Robert: I mean economically it’s price discrimination for allowing students to decide how much to pay for the book. So they can pay.

Zack: So it’s not necessarily that you don’t accept money. You just sort of put it on their end and say, “Pay whatever this is worth to you”?

Robert: Well, it depends on the service level. So they can look at it for free on the Web, as anyone can including your audience, or they can pay $25 for a soft cover, black and white version, or they can pay around $50 for a four-color version, or they can buy it chapter by chapter as a printable PDF.

Zack: So why do that? I know you discuss price discrimination in some of your courses. Why launch the book in that format?

Robert: Well, there’s a whole publisher, Flat World Knowledge, that’s really going gang busters over here in the States, and we’re doing two things. One is, even the top level product is a third of the price of the traditional text book, and we’re trying to get market share. We think that we can make a lot of money selling at much lower price points than the traditional publishers do. It was a few folks from some of the big textbook publishers who branched and they said, “We can do this better,” and they branched off and created this new model. Freemium, I think, is the term, freemium.

Zack: Offer free, sort of bare bolts products and pay up for different, I guess, media.

Robert: Different , right.

Zack: Different form factor.

Robert: Exactly. And it’s working.

Zack: Do you think that’s a trend that’s going to spill over to say traditional publishing, outside textbooks? So will we be reading investment books in the future that way?

Robert: It’s possible. I mean, to some extent it’s already happening, because eBook sales have finally started to take off, and the eBooks tend to be priced lower, at least lower than a traditional cloth bound first edition. The book that Simon and I have written here is a mass market paperback, and it’s going for $9.99 on Amazon. I think that’s the same as the Kindle price. That’s pretty inexpensive for a book these days. But, yeah, it’s already starting to happen in books, and to some extent authors do this when they have blogs. They might put some content up on their blog for free and then try to leverage that for sales of books or consulting services or what have you.

Zack: I think that’s exactly right. I think what’s happening is that the book as a form factor is changing. So it’s not only necessarily that I want the words on the page, it doesn’t have to be a page. It could be digitized. But if I like the book and I like the content matter, I want to plug in deeper into the authors. I want to get more information. I don’t necessarily want to have to buy other things. It’s almost like a subscription. I want to subscribe to everything that comes out that they’re producing around that topic area.

Robert: Yeah. I can see that happening very much, and in fact, so far with this book, which just came out on Tuesday, we’ve asked people if there’s a website associated with it and if we’ll keep up with the indicators and keep up the commentary on the indicators on the website, which sounds like a great idea. I don’t know if it’s going to work economically for us, but I can see some folks doing that or us handing it off to somebody to do.

Zack: So your new book, “The Wall Street Journal Guide to the 50 Economic Indicators That Really Matter:  From Big Macs to ‘Zombie Banks,’ the Indicators Smart Investors Watch to Beat the Market,” what was the genesis? I mean, are you teaching some of this material? How did you conceive of this book?

Robert: I wasn’t. I was teaching global perspectives on enterprise systems at the Stern School of Business at New York University, and Simon was in my class. He’s about the same age that I am, and he was going to get into financial journalism and he knew of my very keen interest in the history of financial institutions, markets, and regulations. So we stayed in touch over the years.

What really got us to go from talking about doing a book of this sort to actually doing it was the news coming out of the financial crisis of 2008, with individual investors who couldn’t retire because the stock market lost so much value. I don’t know if you remember those stories, but they certainly struck us, and we couldn’t believe that here in the 21st century there were still investors, near retirement, who were almost fully invested in the stock market. We were just astounded by that and decided that we needed to write a book that would go over some of the basics of investing.

Zack: Is that an educational fail, or is that a failure of the way the financial services industry is structured with people selling products and things like that?

Robert: Well, I think it’s both of those things, and it’s also a regulatory failure to some extent as well. I wrote many articles after the crash saying there are a lot of folks to blame here.

Zack: No shortage of that, right?

Robert: Yeah. I even wrote one blaming historians, and the thesis was that we don’t spend enough of our total historical resources studying past crises, past booms and busts, past regulations. So if we did that, we would have realized much sooner that the subprime mortgage crisis was going to end badly, because it already had six times in U.S. history. But who really cares what happened between the Civil War and World War II, right?

Zack: Sure. Sort of out of sight, out of mind, right?

Robert: Yeah, even though they were all basically due to the same set of causes.

Zack: So I want to get back to how you view economic modeling and forecasting using indicators later, but can you explain exactly where we went wrong? What should we have been looking at?

Robert: Oh, well, I think that investors should look at a much broader range of indicators, and that’s because the economy is such a large, complex, shape shifting beast. It’s not something that can be reduced to a couple of numbers, and you have to be careful about what you hear on television or some of these talk radio shows that run late at night and all of that, because those folks are not perfect to be sure and sometimes they might have financial interests that run directly counter to the individual investor’s interest.

So we think the individual investor really needs to get his or her own feel of the economy, and the best way to do that is just to immerse themselves in various indicators, have a basic understanding of what they are and what they mean, and then to keep track of them for maybe six months. Then start to play around with paper trades, just fictional trades just to see how you’re doing. Then maybe a year out, if you feel confident, then start to put real money into the market. But to continue always to look at a broad swath of indicators so that you can really have a feel for all the nuance of the economy, which is what Alan Greenspan used to do.

Zack: Right.

Robert: It doesn’t always mean you’re going to be successful though.

Zack: I was going to say that didn’t necessarily end well. But can you point to specific indicators, I guess, that we currently as investors or the media is fixated on that may be lagging indicators or may not be as strongly correlated to what we think they’re supposed to tell us.

Robert: Well, the key, we think, is to try to figure out where we are on the business cycle. So the 50 that we have in the book actually include leading indicators, which can help investors to figure out where the economy is heading, coincident indicators, ones that give us a good feel for where the economy is right now, which might sound trivial, but actually is more difficult to do than it sounds, and lagging indicators so that we know where the economy was coming from. Some of the common ones, like GDP, we include in the book just because we also wanted it just to be a bit of a handy reference guide. But other indicators hardly anyone has heard of or uses though they appear to be valuable at what they do, either foreseeing the future or telling us where we’re at or telling us where we’ve been.

Zack: Can you give a specific example of one of those?

Robert: Well, one that we like to talk about is called the Vixen Index. It’s sort of a play on the VIX Index, which is a measure of fear in the markets. The Vixen Index is also called the “Hot Waitress Index.” The notion behind it is that you should pay attention to all sorts of clues that the economy is constantly spitting out, one of which is that in good times, adjusted for regional differences of course, your wait staff should not be very attractive, and as your wait staff gets more and more physically attractive, that is a worse and worse sign for the economy, because what it basically means is they’re not getting the modeling jobs. They’re not getting the acting jobs, and they’re starting to displace their homelier competitors in lower paid, lower skilled markets.

Zack: Ultimately though, and I’ve read the book, the book does a great job of at a high level saying here’s why we need indicators and then drilling down into each individual indicator and even going so far as to say the ability for this indicator to help make you money is stronger than a different one. But ultimately, intellectual honesty is important. Is there really a way to know? I mean Alan Greenspan was a very smart person, and he got it completely wrong, I think.

Robert: There’s a television show out here called “The Daily Show” with Jon Stewart. I don’t know if you’re familiar with it.

Zack: Yep.

Robert: Greenspan was on “The Daily Show.”

Zack: He had Cramer on also, right?

Robert: Oh, yeah, he nailed Cramer good. But I sort of felt bad for Greenspan, because Jon Stewart nailed him, and it dawned on me at that moment that I think that Greenspan’s mental acuity was not what it once was and that he probably served one term too many and that actually the mistakes that the Fed made at the end of his reign were because of his diminished intellectual capability just due to advanced age. So I wouldn’t take what happened as a sign that those immersive techniques that we’re talking about as a bad one.

Zack: No. I wasn’t trying to pick on Greenspan in any way. My point is that ultimately it’s sort of like the Heisenberg uncertainty principle.

Robert: You still can’t tell the future.

Zack: Right. So we have to do the best with the tools that we have.

Robert: Right. We just think that if you add more tools to your toolbox, that when something weird comes up, something that’s unusual, you’ll have that metric ratchet set right to fix that particular problem, or you’ll have the blowtorch handy, whereas other investors might not have it, because the economy is so very complex. A lot of the indicators, as we talk about in the book, are far from ironclad. There are all sorts of tradeoffs involved between the speed with which they come out and their accuracy. So some of them come out very frequently, which might sound like it’s a good thing if you’re really trying to time markets. But there’s a lot of noise in that sort of data, and oftentimes they get revised later on and quite drastically. So if you’re relying on something that gets revised by quite a lot later on, that’s not good. You need to have other means of information so that you can really get a complex, nuanced handle on what’s going on in the economy.

Zack: Do you think the, and you mention this in the book, so sometimes it’s not the first order number that comes out that’s important, it’s more the derivative. It’s the time series, how this indicator compares to what it was last month and the quarter before. Does the media do a good job of capturing the importance of some of these indicators?

Robert: Sometimes. Other times not. It seems like the media feels as though it has to have an “explanation” for every time the stock market moves a little bit.

Zack: Right. Three points in each direction, right?

Robert: Yeah, and it’s very as is or ad hoc. Osama Bin Laden was shot this week, so the stock market went down as if that event affected all stocks in all sectors. It’s a lot of just pure guesswork where they talk to a couple of traders and the traders are still trading and they’re just getting a very small piece of market sentiment, but they report it as if that’s the entire situation, even though theory tells us that some of the movements are essentially random. But they still feel the need that they have to come up with some sort of explanation for it.

Zack: So I guess one of the trends we talk about, on the podcasts and on my blog, is the ongoing, continued move towards increased transparency and more cross sectional data that’s making its way out into the marketplace. Have you seen, given your course of studying this of writing the book, the emergence of new types of indicators that we wouldn’t necessarily have thought of a few years ago? Just because that type of data is more readily available.

Robert: Well, one new indicator that we include in the book is called the CAO, the Credit Availability Oscillator, and I think I would include that in one of the new ones that technology has rendered feasible. The ADS Indicator out of the Philly Fed, which is the not the Philly Business Outlook Survey, which is what everyone looks out, the ADS is a national index, high frequency data. It’s updated at least weekly and certainly computerization and the Web make that possible. It comes out of the Philly Fed for free. They put it up on their website. They may even tweet it as this point for all I know. But it’s a pretty good, solid indicator that’s made possible by improvements in technology and information dissemination, and it’s part of the Federal Reserve’s move towards more transparency.

Zack: So outside of the Vixen, which is sort of a non-economic indicator . . .

Robert: No. I wouldn’t call it non-economic. What it is, is it’s non-quantitative.

Zack: Non-quantitative, that’s fair.

Robert: Yeah, it’s kind of like an individual Beige Book, almost. The Beige Book is that long report that comes out of the Fed again that is a narrative of what different business leaders reported to the various Fed districts. A lot of people don’t like to wade through the Beige Book. They might like at the summary, but there can be some juicy details in there that astute investors can use to get a feel for where the economy’s heading. We pointed one out in the book. It was the first glimmer that there was trouble in the subprime market was actually reported in the Fed Beige Book for the San Francisco District. Somebody paying close attention to that could have picked up on it and traded accordingly and avoided the mess that came 18 months later.

Zack: So true. I guess where I was headed with the question was that I’m thinking of something like futures markets that aren’t necessarily economic in nature, they are quantitative, but they’re not necessarily derived from economic data. It’s two seemingly, well-informed people wagering on a future event, and they seem to be relatively accurate in their forecasts. You didn’t mention those, but do you see those as sort of new indicators that technology is able to disseminate and create?

Robert: Yeah, we thought that it was too complex for the average individual investor, and we struggled with some of these newer things because they’re not necessarily proven yet. We wanted to give investors indicators that are pretty well proven and still seem to be effective, things like real interest rates and the yield curve as a predictor of recessions, credit spreads, the TED spread, M2 growth, indicators that definitely have some proven track record.

Zack: How did your book differ, I guess, from some of the other books? I mean, obviously Baumohl has a relatively well-known and well-selling “Secrets of Economic Indicators.” How did you diverge from some of the other books that are out there?

Robert: Well, we tried to concentrate more on the economics. In fact, we broke the indicators down into that classic equation that everyone learns in Principles of Macroeconomics – Y, your output = C+I+G+NX, or Output = Consumption + Business Investment + Government + Net Exports. That’s about half the indicators, and then we have a large number of indicators that point to multiple components of GDP. Then we end with a lot of indicators that help people foresee inflation and market fear and economic uncertainty. So we try to concentrate more on the economics. Simon and I are both very sarcastic individuals, and at least we think that we’re witty and we’ve tried to build that into the text. So it’s not as dry a read as most economic indicator primers are.

Zack: That, I think, you were totally successful there. It was written well. It flowed. I think you’re targeting every investor out there, not just like a professional or a hobbyist.

One question I ask of . . . sorry go ahead.

Robert: I was just going to say Larry Kudlow said that he’s going to keep a copy on his desk for handy reference.

Zack: That’s a great approbation.

Robert: Yeah.

Zack: So, one question I ask and this is really germane to what you’re talking about. I ask all guests on the show this, but what kind of resources are you turning to online or offline that would help people stay on top of some of these indicators? I think you mentioned Briefing.com in the book. Are there other sources of this information free and maybe premium that people should keep an eye out for?

Robert: Definitely, and at the end of each indicator we include a discussion of where to find it. Much of it, but not all of it, can be found on the Wall Street Journal’s website under their economic calendar. But there are other sources for all of these. Some are government agencies like the Bureau of Labor Statistics, the Bureau of Transportation. The Fed has some wonderful data, especially the SRED database. The St. Louis Fed’s website has just thousands and thousands of series of data. It’s not just interest rates and reserve levels either. They keep track of a very large number of variables. There is a website called Kitco that’s good for metal market watchers. The Treasury puts out some good information. The White House has data on government budgets and whatnot. Just make sure that you put WhiteHouse.gov in at the end of the URL on that one.

Zack: You wouldn’t want to get the other site, huh?

Robert: Yeah, yeah, yeah. The other site might be very interesting for some, but won’t probably help you with . . .

Zack: It could be part of the Vixen Indicator.

Robert: Oh, we hadn’t thought of that. That’s a good one. If there’s a second edition, that might make that in, Zack.

Zack: Just make sure you mention it.

Robert: We’ll credit you on it. British Bankers Association, the Bureau of Economic Analysis, the Census Bureau. If anything, the issue is there are so many sources. We have like four pages worth listed at the end. They require you to go to different sites. So that’s why somebody suggested that we aggregate all of this on one site and just give the skinny, just the headline information, and then an easy link to the primary source, to the original source.

Zack: I think it’s a great idea. I mean theoretically you could create that relatively cheaply, and I think that would be a really valuable source to people. I know it would.

So I guess that would conclude our podcast. Congratulations on writing a great book, and I hope it sells really well.

Robert: Thank you.

Zack: I hope you enjoyed our conversation with Professor Robert Wright, the co-author of “The Wall Street Journal Guide to the 50 Economic Indicators That Really Matter:  From Big Macs to ‘Zombie Banks,’ the Indicators Smart Investors Watch to Beat the Market.” Run out, get the book. It’s available in paperback and on Kindle, which is where I read it.

Come back to Tradestreaming.com, our blog where we’ll have some more information about Wright and some links so you can learn a little bit more about him. Appreciate your time and energy, and we will be back at you soon.

More resources