Data Drawbacks

Story Highlights:

•  Lately we've seen a spate of economic data revisions—including two notable GDP figures.
• Market forecasters beware! Economic data typically fluctuates month to month and are backward-looking—they tend to lag the market (which looks forward).  
• Economic indicators have their place, no doubt, but looking to them for precision is a mistake.

Spirit of giving aside, let's face it—it's inevitable a few of those goodies underneath the tree will be a letdown. (Come on, it's tough to get gleeful over three new pairs of dark socks…). This year, to some, the surprises and disappointments came early—economic indicators are lately being wildly revised.

Notably, US GDP was revised for a second time to a lower 2.2%—from an initial reading of 3.5% and a previous revision of 2.8%. First of all—why all the revisions? It gets to the heart of economic indicators and their inherent problems. Investors and economists want "real time" data. That is—we want it now or yesterday! Problem is, conjuring a statistically valid and rigorous reading for, say, the economic output of the most diverse and huge economy in the world is, um, tougher than it looks. Stuff like an "initial" GDP reading is in reality a miasma of surveys, wonky calculations, assumptions, and the like. Said differently, it's not as if there's a clean number that's gathered up, tabulated, and reported. It's an art as much as a science. They do it all post haste because people want to know as soon as possible what happened. We're willing to give up a little in accuracy to gain a little speed. As the months pass, more "concrete" data become available and a few of those assumptions can be made clearer. Even with time, there's no sense in fretting over a tenth of a percent in fluctuation—indicators are too imprecise. (Head on over to www.bea.org sometime and check out how GDP is calculated—the amount of crazy calculation will give you night terrors, we promise.) It's big moves, or results way far outside expectations, that matter. In a so-called "indicator", the best to be hoped for is a general idea of the direction and magnitude—trends and cycles. So, yes, economic data is useful to a certain extent—they allow for apples-to-apples comparison over time. GDP may be a flawed calculation (oh, it is), but at least it's something that can more or less be compared through history. That's surely worth something.

The recent less-strong US GDP figure may have seemed a hard lump of coal to swallow, but for investors a revision is something of a trite and ponderous thing. What to do with it? The answer—mostly nothing. Markets perpetually look forward. Proof of the holiday pudding is this week—GDP was revised down but markets are up. Why? Markets are already thinking about next year, not last quarter. A revision of the past is a nice thing to know but offers little real juice for the thirsty forecaster.

Revisions lately are varying more wildly than usual (Japan's GDP reading was revised from an initial 4.8% to 1.3%, for example). Why that's the case could be any number of things. But undoubtedly it has to do with the increasingly complex and dynamic global economy—a thing that's getting more and more difficult to accurately depict in a single, neat number. Particularly now that the global economy is coming out of recession and gears are shifting back into growth—things can get wonkier than usual.

But for all that, how to use these numbers in analysis? That too is far more subjective than folks realize. Should we compare today's jobs numbers to those half a year or a year ago or to those last week? What are the virtues of year-over-year versus sequential analysis? Which one has more "truth" in it? Depends on your point of view. This is precisely the way numbers are often "massaged" into fitting into a larger gestalt. Naysayers will say, "The lower US GDP means recovery will be really slow or we'll have another dip!" Optimists will say, "Hey! It was still growth!" Who's right? The data simply can't tell you—it's your call.

We've used this space over and again to say markets are the ultimate leading indicator. Economic indicators are a fine thing for investors, but use them wisely—and always keep one eye to the future.