Confusing Politics With Economics

A core tenet of my investment philosophy is that you can't think clearly about the future unless you have a firm grasp on the present -- where the market is now and how it got here. This is true regardless of whether you're a trend follower, a swing trader or a fundamental analyst.

At any given moment, however, the market is hardly a reflection of the day's headlines. All too often, I see and read pundits discussing the indices as if they react primarily -- even solely -- to the wires and latest press releases. If only it were that simple.

The Latest Culprit

Take the recent selloff from June 30 to July 26, for example. As the indices have been flailing about, groping for a bottom, the chattering classes (including me) have searched for an explanation. In their hunt for what's been bothering the market, they have discovered a new culprit: politics!

Consider this comment in Monday's Wall Street Journal. A bulge bracket firm's political analyst observed: "I would consider that uncertainty around the outcome of the presidential election is one of the major influences on the skittishness in the U.S. market."

As Jim Cramer would say, Wrong! This observer gets the cause-and-effect equation exactly backward. Unfortunately, this misunderstanding of the relationship between politics and economics is all too typical. Given the search for certainty in an uncertain world, confusing foundation and consequence -- cause and effect -- is a regular occurrence. Politics perfectly epitomizes that foible.

Causative Errors

What are "causative errors"? This all-too-common analytical blunder comes in several forms. It often happens in attempts to oversimplify the market's natural complexity. The interrelationships of many different macro events don't make for good sound bites, yet we hear short buzzwords describing what's moving the market on any given day.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].