Month: January 2015

GDP: how accurate are they?

Posted on by fqzhang

As educated citizens, there is no single measure of economy that we care more about than the GDP figure. Any increase or decrease in the change of GDP growth rate are bound to make national headlines. Witness the news media frenzy following the GDP figure release for China:

China GDP 2015 GDP news

Clearly, as a society, we regard the GDP figure as something more than a number that measures how large the economy is or the rate at which it is expanding (or contracting); but rather, we see GDP as almost a sacred figure. We take pride in our national economic output, we base our consumer confidence based on these numbers, and more importantly, politicians and decision-makers based their course of actions upon the changes in these numbers from year-to-year. We take the number as something that’s grounded in reality and something that’s unquestionable. And while some would argue about the usefulness of the GDP figure as a measure of the standard of living, most would accept the accuracy of those numbers. But how accurate is it really of a nation’s economic output? Here are several surprising facts that shows that perhaps GDP is not all that it seems. (For a similar list about inflation, click here)

  1. Ghana GDP revision: In 2010, Ghana decided to reexamine its GDP figures by using a different base year to calculate growth over time. The result? GDP was revised upward by over 60%.

Ghana GDP

  1. Nigerian GDP revision: In 2014 Nigeria recalculated its GDP (using a different base year) to include more sectors of the economy such as telecommunications. This recalculation resulted in Nigeria shifting its economic output by upwards of 80% and leading it to become the largest economy on the African continent, surpassing South Africa.

Nigeria's GDP revision

  1. Japan’s GDP calculation mistake: For the 4th quarter of 2012, Japan’s GDP was calculated as shrinking by 0.3%. In reality it increased 0.1%. This miscalculation was the result of a failure to correct seasonally-adjusted figures and misreporting of the GDP deflator (a measure of inflation).

Japan's cities at night

  1. An Excel error and its impacts on public policy debates: In 2010, two economists, Carmen Reinhart and Kenneth Rogoff, published a report claiming that countries with High Debt/GDP ratios have lower growth on average. To support their argument, they used data from 20 advanced economies and calculated their average rate of GDP growth. However, they neglected to select 5 countries (Australia, Austria, Belgium, Canada and Denmark) with both high Debt/GDP and GDP growth rates, skewing their result and the conclusions they draw. This mistake had profound implications. Congressmen and others within the federal government cited this as proof that our federal deficit each year needs to be reduced by cutting a variety of programs, so that our economic growth rate may remain unaffected.

GDP excel error

While this is not strictly a GDP error, it shows how a small mistake in calculating GDP data can seriously affect the conclusions drawn from it.

  1. US quarterly GDP revisions: For the first quarter of 2014, US GDP was revised downward a couple of times, each time suggesting that the GDP contracted further on an annualized basis. Much of the downward trend is the result of less-than-expected consumer spending on healthcare, and the lackluster performance of exports. In part, the GDP contraction was due to an exceptionally cold winter in the US.

US quarterly GDP revision

  1. Bank of Canada’s forecasting errors: Even in developed countries, economic forecasts can often go wrong. The Bank of Canada (Canada’s central bank) failed to forecast the small economic downturn in the fall of 2012. The bank of Canada’s forecasts are often overly optimistic. Out of 5 of 7 time periods studied, the average economic growth forecast is 0.6 percentage points higher than the actual; and 75 per cent of medium-term forecasts by the Bank of Canada were overly optimistic.

GDP growth in Canada per capita

So here it is. So the next time you hear in the news about GDP figures, remember that GDP is a number that’s created by people. Most often, these numbers are correct and give a good picture of our nation’s economic health. But at times, we base our GDP figures, past or future, based on faulty or incomplete information. And sometimes, we make plain simple mistakes.

Investment Analysis: Struggling industries and prospective short-sell candidates

Posted on by fqzhang

As 2015 is starting, many in the investment circle are looking at what new industries and companies are presenting opportunities. While this is important, it is just as important to note what industries not to pick for this upcoming year. Here is my short list (no pun intended) of what industries are facing some significant headwinds and is good to avoid in this coming year. (If you are long (i.e expecting the value to go up), that is. But if you are looking for shorts (trying to profit by a falling in stock price), feel free to be as aggressive as you like; but be warned, as the great the economist John Maynard Keynes said, “The market can stay irrational longer than you can stay solvent”.)

  1. Small Oil and Gas companies with high fixed costs

Oil and gas are among the largest industries in the world (with an estimated 5 trillion dollars in revenue, rivaling the tech industry). Due in part to the massive stock market boom in the last few years, many small oil and gas companies emerges in the public markets. They range from extraction companies to oil exploration to small manufacturers of drilling equipment. With a falling oil price that is not likely to rise any time soon, these small producers with limited resources will likely falter. Moreover, natural resources extraction is a highly capital intensive industry and the firms will likely take on massive amounts of debts to finance its projects. It is estimated that drilling each oil well costs about 3 to 4 million dollars and small companies with a highly leveraged structure and few prospects for growth will be the likely victim in 2015. (Interested in Big Oil and corruption? click here For more on how the falling oil prices are affecting nations around the world, see here)

  1. Small tech companies that have no prospects of being bought up by the big guys

In this category, the companies that come to mind will be the small software development firms, such as app-makers that makes their business around a single app. For example, Zynga, the maker of the popular app game “Farmville”, is one such company. The company is involved in the social gaming category and have not expanded by much in the last couple of years, and are instead are trying to monetize its existing products. For a company involved in app-development, if no new apps are introduced continually, then the firm will simply wither away when demands for the current app disappears (as it most certainly will since consumer tastes are constantly changing). Monetization will be difficult, since a majority of the company’s revenue still comes from selling of advertising space and the market is increasingly saturated by the amount of advertisings out there, and increasing diminishing rates of return. Of course, the best that these tech companies can hope for is to be bought up by the larger players such as Facebook. However, with the proliferation of software companies, larger tech companies have more options to choose from and will take care to only add firms that adds value to the company’s operations.

  1. Small biotech or pharmaceuticals purporting to have “wonder drugs” or new “breakthrough technologies”

For those of you who subscribes to some form of investment newsletters (it doesn’t matter if they are free or charge you hundreds of dollars per year), you have no doubt saw a number of different promotions that talks about how a certain company is on the verge of growth. With a booming biotech sector, a lot of less credible companies have been swept up as well. These companies can have the following traits in common:

  1. Involving cancer-curing or purporting to cure multiple diseases at once with a single drug. These are often simply scientifically unsound, and investors should do some basic research on the subject and use common sense in sorting some of these issues out.
  2. Often in the early stages of the clinical trials, often Phase I and II. The early trials is to simply establish the safety of these medicines and their efficacy; these can often be subjected to statistical manipulation. (ex. in a trial for breast cancer treatment intended for women, the results show that no significant results have been found. However, the company claimed that the results work for a sub-group of that population. The population becomes much smaller and perhaps is simply the results of random chance.)
  3. Long clinical stages and delays in pushing forward to the next stage or toward FDA approval. If a company is a scam or have a drug that is on the verge of failure, the company will likely take as long as possible to “test” the drug. They will take their time for as long as possible in order to reap profits for insiders. Sometimes, some of these companies will even “retest” their drug once more for a certain stage, claiming insufficient data. This is a huge red flag, for a successful drug company will want to rush forward to start monetizing the drug by getting FDA approval. Delays to do so could suggest that the company is nothing but an elaborate promotion.

Note, I am not suggesting the biotech sector as a whole will do poorly this year; after all, the biotech sector, as measured by NASDAQ Biotechnology Index (ETF), is up around 30% from over a year ago and there is no reason to think such a trend will not continue, albeit at a slower pace.

  1. Restaurants and related services that are heavily dependent on consumer cyclical spending

Last year, several newly IPOed restaurants have taken a hit following the miss in expected earnings (ex. Potbelly’s, El Pollo Loco). The struggles in the restaurant industry is not lost upon many professional investors; in fact, some of the most heavily shorted stocks (as measured by short interests) in the US are in the restaurant sector. Restaurants in general are low-margin, with high fixed costs, with tremendous competition, and susceptible to variances in consumer sentiments. All of these makes them good companies to avoid investing in at any given time. But in 2015, there are macroeconomic factors at play here as well. Even though the US economy have outperformed its peers in the developed economies, consumer disposable incomes have not risen appreciably over the past year or so. Americans simply aren’t spending as much on restaurants as before, and the growing competition for healthy food options left many traditional restaurant chains and fast-food restaurants little options but to change what they are offering to clients. These changes will take a long time to implement, and will be extremely costly, even if they are successful at all. (McDonald’s recent advertising campaign is a good example of a restaurant trying to reshape their brand image).

Then there are these companies that have certain characteristics that makes them a bad investment in any scenario, but especially so with the bull market that we have been having for the past few years.

Among many economists, the longer the bull market runs, the more likely the crash in the market will be severe. Therefore, the companies that have been swept up in the bull market ride will be the first ones to fall.

  1. Companies in industries with low barriers to entry and no competitive edge that cannot be replicated

A name that comes to mind in this case is GoPro. The company essentially does one thing, which is to produce cameras that are frequently used by outdoorsman. This sole area of operation is inherently risky in itself. However, with the passage of time if the business is successful, there is no reason to suspect why larger companies with significantly more resources will not pursue a similar line of business and crush the competition. Companies that are reliant upon a single product or service are extremely vulnerable.

  1. Foreign based companies with obscure operations

The stock market boom not only attracted bad domestic companies to IPO. Many foreign companies are also taking notice of the market and want to raise money as well. Some of these companies may indeed have good intentions of raising money to fund their operations. Or they may simply be a fraud and simply want a piece of the actions in the market and enrich themselves. These companies can have names that sound grand, invoking their national titles and inflate their own importance. (They may have a naming structure like “‘name of country’ – ‘industry’ corporation”. i.e. Sino-Forest Corporation). Many of these companies claimed that they have great growth potential in their respective home country and it is next to impossible to ascertain what they are saying is true. A few years back, there was a huge wave of Chinese reverse mergers (i.e. a private company is taken public by purchasing a public shell company) that IPOed in the United States. Many of these companies banked on the investing public’s optimism in the economic growth of China and cooked their books to paint a rosy picture for themselves. Eventually, the frauds were eventually exposed. Many of these companies have complicate structures with unclear relationships with their parent company or its subsidiaries. Sometimes, it is also unclear how the companies make their money or the level of their debt obligations (often disguised as other business segments).

One of the things you might have noticed is how many times I have used the word “small” in the preceding passages. This is key. Smaller companies in all the industries mentioned have a much higher chance of going bad or simply being fraudulent that the large ones. I believe that the market is efficient for the large-cap companies that have been carefully scrutinized, and the prices are likely where they should be. (Of course, there are cases like Enron, but in that case, the business is so indecipherable that it is bad idea to be even thinking about it). So when investing, remember to keep the company’s size in mind.

Note: The above article expresses solely my personal opinion. This is a blog, after all. Please do not utilize the articles as investment advices; or if you do (I will be sincerely flattered that you would listen to a sophomore in college), please do your own due diligence before investing. I do not hold any stocks or any form of investments whatsoever.