Succinct Summation of Week’s Events 1.22.16 (plus "Outcome vs Process")

It's time for the week's wrap up and fortunately this week wrapped up on a much more positive note than last week.  As a reward for those of you not panicking, today's Big Picture column featured a trip back to Finance 101, a refresher in the basic investment strategy of "outcome vs process" and why it is always better to be focused on the latter rather than the former.  Hope everyone had a great weekend.

Succinct Summation of Week’s Events 1.22.16

January 22, 2016 4:00pm by Barry Ritholtz

Succinct Summations for the week ending January 22nd, 2016

Positives:

1. After three straight weeks of selling, stocks get a reprieve, finishing positive on the week.
2. Existing home sales came in at a 5.46mm annualized rate, up 14.7% m/o/m.
3. MBA mortgage applications composite rose 9% w/o/w.
4. Bloomberg’s consumer comfort index came in at 44, down just slightly despite the lousy January for stocks.
5. Manufacturing PMI came in at 52.7, up from 51.3 previously.

Negatives:

1. CPI still not budging, -0.1% m/o/m, core CPI rose 0.1%.
2. Housing starts came in at an annualized 1.149mm rate in December, down 2.5% from the previous reading.
3. Jobless claims rose came in at 293k, the 4-week moving average is up to 285k, from 278.5k previously.
4. Housing permits fell to 1.232mm SAAR, a 3.9% m/o/m decline.

Outcome versus Process

January 24, 2016 10:30am by Barry Ritholtz

My Sunday Washington Post Business Section column is out. This morning, we look at whether you should be outcome or process focused.The online version used the descriptive headline You’re obsessed with outcomes. Here’s why attention to process pays off while the print version had the more nuanced “So you won — but let’s talk about your game.”

The focus on outcome over the more subtle process is a common error made by sports fans and investors alike. The column looks at why this is problematic, and what you should do about it.

Here’s an excerpt:

“Process is simply the methodology used to accomplish an undertaking. It could be a simple checklist or a complex systematic approach. Process focuses on the specific actions that must be taken, regardless of the results.

Outcome is the result; it could be due to skill, luck, intelligence or many other random factors. At the end of the day, outcome is who won or who lost the game, how many planes landed safely, what stocks went up or down and what surgical patients lived or died.”

The column focuses on how why those investors who focus on outcomes over process are looking at the wrong things.

Love the graphic, too!

Source:

You’re obsessed with outcomes. Here’s why attention to process pays off.

Barry Ritholtz
Washington Post, January 24, 2016
wapo.st/1JtAjSz

Get There

You’re obsessed with outcomes. Here’s why attention to process pays off.

This advice from President Harry Truman is perfect for investors, too: "You know, it's easy for the Monday morning quarterback to say what the coach should have done, after the game is over. But when the decision is up before you, the decision has to be made."

By Barry Ritholtz Columnist January 23

Sports fans and investors tend to make similar errors. Perhaps the biggest is focusing on outcomes rather than process. Sports fanatics are all Monday morning quarterbacks; they can read you chapter and verse — after the fact — what should have been done late in the game on 4th and goal from the 2-yard line.

It’s called hindsight bias, and it afflicts investors, too. They can tell you what asset classes you should have owned last year, which hedge fund manager you should have invested with 20 years ago, and why you should have bought Netflix, Tesla and Apple about 5,000 percent ago. (Thanks for nothing!)

So what is process, and how does it differ from outcome?

Process is simply the methodology used to accomplish an undertaking. It could be a simple checklist or a complex systematic approach. Process focuses on the specific actions that must be taken, regardless of the results.

Outcome is the result; it could be due to skill, luck, intelligence or many other random factors. At the end of the day, outcome is who won or who lost the game, how many planes landed safely, what stocks went up or down and what surgical patients lived or died.

In sports terms, think of process as your playbook and outcome as the final score. In investing, process is your approach, investment style, discipline and consistency, while outcome is your return or performance.

Imagine you are watching two people in a coin-flipping contest. One of them flips 10 heads in a row; the other’s are more random — heads, tails, tails, heads, tails, etc. Are you willing to bet a substantial sum that the first flipper’s next toss will be heads? If you said yes, you are outcome focused.

It seems brazen, yet that is exactly what many investors do. They chase the hottest coin flipper of the moment. In finance, that is the person with a “hot hand” — the mutual fund whose manager just finished a great streak, someone who ended up on the cover of a magazine, or any recent award winner.

If you have not analyzed and understood a manager’s methodology, how can you possibly know whether the results are due to skill or chance? We are all too often, to quote Nassim Taleb, fooled by randomness.

Successful results in investing could very well be a mere coincidence — a result without any underlying causation on the manager’s part. Meaning, the outcome was not the result of process, but rather, dumb luck.

Perhaps that manager’s investing style (momentum, value, trend following, etc.) came (temporarily) back in vogue. Maybe his sector became red hot, or the part of the world he focuses on is seeing a (temporary) boom. What looks like personal greatness very often is not (and vice versa).

This is not to say you should always ignore bad outcomes. A series of poor results may indicate an issue with process.

Ironically, investors as a group have a tendency to attribute their own successes to the skill and insight they possess; at the same time, any losing investments are blamed on bad luck. That’s outcome focus married to ego, and it’s not how you make money in the markets over the long term.

Why are we so easily fooled by random outcomes? The pattern recognition subroutine in your brains evolved to identify threats. That shadow in the tall grass might be a predator waiting to make you its lunch. Hence, generating false positives means that you might be wrong 99 of 100 times, but on the savannah, that 100th event saves your life.

People tend to be outcome focused, often to the detriment of choosing a good process. Perhaps another example from outside of the world of finance might be helpful.

Imagine you have a medical condition that requires surgery. It’s a bit tricky, but the procedure has a good chance of success. You interview a few doctors, looking at their academic history, published papers, experience and reputations. You narrow the list to two surgeons and get access to their surgical records, including patient survival rates.

Both surgeons have very good reputations; one works primarily for private patients covered by insurance, the other is at a top medical school. The private doctor runs a success/survival rate of 86 percent, while the medical school doc runs less than 60 percent.

Which doctor do you choose?

If you immediately said the 86 percent doctor, you are outcome focused. You saw the better results and that was all you needed to know.

Others might have wondered why a cutter with a great reputation at a top-ranked medical school had a much worse survival ratio. So you do a little more research into his process. You find that he invented this procedure 20 years ago. He did all of the early experimental surgeries, including lots of clinical failures (meaning bad surgical outcomes). But he refined the surgery, where through trial and error he developed what is now a life-saving technique. Indeed it has since become standardized, thanks to him. Every doctor and patient who followed afterward benefited from his groundbreaking clinical work

Because of his background and work in this area, this doc gets all of the “impossible” surgical cases. When other surgeons don’t think they can do the operation — or don’t want to — they refer it to his medical school. Hopeless and complicated surgeries make up a big part of his practice. People travel from around the world just to have this surgeon do this procedure on them. He has seen every variation of patient, and because of this, he has done more of these operations than anyone in the world.

Based on this new information, which surgeon would you choose? The first doctor was pretty good, but the second doctor is outstanding! If you suddenly are thinking about the medical school doctor with the lower success rate, well, congratulations — you have just become process focused.

The key to becoming more process focused is to understand that good outcomes follow good processes. Without understanding the underlying process, good outcomes could just as likely be due to blind luck as to skill.

You should be reminded of this every time you read the disclaimer “past performance is no guarantee of future results.” What you are actually seeing is an admission about random outcomes. Past performance is no guarantee of future results if the past performance is just as likely the result of luck as it is the result of skill.

Luck = outcome, and skill = process.

We never really know what the source of a good outcome is; however, we have a high degree of confidence what the probabilities are for a good process. A strong process is a guarantee — not of outcome or results, but of the highest probability of obtaining desired results. That’s why it is so important to investors.

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture. On Twitter: @Ritholtz.