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Five Things You Need to Know: The Mediocrity of the Wisdom of Crowds


How the Internet makes you mediocre and degrades your decision-making.


1. How the Internet Makes You Mediocre and Degrades Your Decision-Making

Most of the Internet is making you mediocre and degrading your decision-making. But you know this already. After all, look at your open tabs. Schwarzenegger love child. A Jon Stewart and Bill O'Reilly "debate" recap. More Strauss-Kahn gossip and a list of the banks that paid to put their names on sports stadiums. But you just can't help it, can you? I know I can't. I hate myself for about a third of every link I click online, especially those on Twitter. I can literally feel my brain function degrading as each day I continue to consume countless curated stories about crap I don't care about produced by websites I don't trust. Okay that's the context I want to give you for this Wired Science piece, "Sharing Information Corrupts Wisdom of Crowds."

"In a new study of crowd wisdom - the statistical phenomenon by which individual biases cancel each other out, distilling hundreds or thousands of individual guesses into uncannily accurate average answers - researchers told test participants about their peers' guesses. As a result, their group insight went awry," the article says.

According to the paper's abstract: "This wisdom of crowd effect was recently supported by examples from stock markets, political elections, and quiz shows [Surowiecki J (2004) The Wisdom of Crowds]. In contrast, we demonstrate by experimental evidence (N = 144) that even mild social influence can undermine the wisdom of crowd effect in simple estimation tasks."

And then this as well, with the parts in bold my emphasis:

"We compare subjects' convergence of estimates and improvements in accuracy over five consecutive estimation periods with a control condition, in which no information about others' responses was provided. Although groups are initially "wise," knowledge about estimates of others narrows the diversity of opinions to such an extent that it undermines the wisdom of crowd effect in three different ways. The "social influence effect" diminishes the diversity of the crowd without improvements of its collective error. The "range reduction effect" moves the position of the truth to peripheral regions of the range of estimates so that the crowd becomes less reliable in providing expertise for external observers. The "confidence effect" boosts individuals' confidence after convergence of their estimates despite lack of improved accuracy."

The bottom line: The Internet, Twitter, Facebook, self-selected crowds, and particularly online media companies who are driven almost exclusively by analysis of hundreds of thousands or even millions of individual search patterns in order to produce or "curate" the "best" content for large crowds, is entertaining, but also a giant network of mediocrity pushing you toward poor insight and terrible decision-making. This would be true in all spheres, from sports to celebrity and pop culture information and, yes, business and financial markets.

"If you read what everyone else reads, you will think what everyone else thinks." - Haruki Murakami

2. Apple Cheaper Than Colgate, P&G

"After the sell-off over the past few days, Apple (AAPL) is cheaper on a P/E basis than defensive names like Colgate (CL), Procter & Gamble (PG), McDonald's (MCD), and Avon Products (AVP). No smoke and mirrors," writes Conor Sen. Why? The theory is that investors who have traditionally only invested in bonds are being forced into high-yielding equities by low yields in the fixed income market. This makes sense to me, but I expect over the remainder of the spring and into summer for this to continue.

I looked through these charts on a longer-term MONTHLY DeMark basis and there are not yet signs of exhaustion for the high-yielding stocks while we know that domestic indices and stocks like AAPL are showing signs of exhaustion. This will not last forever. And as you know, my take on AAPL, while not exactly bearish, is that I believe its outperformance versus the SPX is likely at an end.

3. Why is Income Volatility Not Equivalent to Income Uncertainty?

Sure it's a wonky question -- the key question in this Federal Reserve paper analyzing income uncertainty -- and the mere fact it has to be asked speaks to the level of ineffectiveness of current economic models in understanding and predicting household behavior. The reason this is important in economics is because if there is rising income uncertainty widespread across households then we can anticipate that there will be less discretionary spending and more savings to shore up household balance sheets against income shocks.

This is one key finding: "[O]ur analysis shows that since the early 1970s, income uncertainty rose more at farther horizons than at nearer horizons but the persistence of forecast errors was little changed, suggesting the increase in income uncertainty cannot be solely accounted for by the increase in variances of transitory income shocks."

In other words, while intuitively one would expect increases in variances of income shocks to directly influence household income uncertainty, the reality is that they do not fully account for forecast errors, which means something else must be going on.

But here is something even more startling to traditional economic models: "We find that aggregate saving is 3% higher in the economy with greater income uncertainty, where the part of the saving due to precautionary reasons is more than 30% higher. This result presents a counterfactual with respect to the aggregate saving rate observed in the data, which decreased appreciably during this period. The difference between the data and the model economy calls for future research to identify other mechanisms that may have potentially discouraged saving over time to a greater degree than precautionary motives should have encouraged saving."

The Socionomics hypothesis is that unconscious fluctuations in social mood determine the character of social events. Therefore, if it's possible to model these waves of social mood, then we would expect to find correlations between waves of negative social mood and rising income uncertainty, waves that would account for forecasting errors of traditional economic causality. For example, a line of inquiry into household income uncertainty during transitory income shocks that occur in bull markets and rising periods of social mood would likely show that spending and credit consumption are increasing even as uncertainty increases, a causality that traditional models would not be able to account for since there is no distinction made between income shocks during periods of positive social mood and income shocks during periods of negative social mood.

While the Fed paper is wonky, yes, it's useful as a very pointed and direct way to show how/when/where the types of models that econometricians use fail. More to the point, the paper's authors admit to the 'counterfactual' but fail to recognize even why/when/where their models may be wrong.

4. Green Hills, PA is My Kind of Town!

Have you ever heard of Green Hills, PA? It's a small town. Actually, it's a tiny town, what they call a hamlet, roughly one square mile situated between a country club and a horse farm. It has 29 residents and an annual budget of $10,000 used to pay for a few legal bills and to contract with a volunteer fire department. Green Hills was created in 1978 for one thing and one thing only: to sell booze. Now that's my kind of town!

Anyway, the point of this is that tiny towns such as Green Hills spread all across America are facing pressure from states to consolidate with larger neighboring towns to save on services, according to Bloomberg. Pennsylvania will face a budget deficit next year of $4.2 billion. Shortfalls nationwide could reach $112 billion next year, Bloomberg reports.

"I've never seen such a consistent push across so many different states and across so many different municipalities to say, 'We have to look at this,'" Charles Zettek Jr., vice president of the Center for Governmental Research in Rochester, New York, told Bloomberg. The nonprofit center has advised governments about consolidation in New York, New Jersey and Ohio."

Still, you have to love a town that was created just for the purpose of selling booze.

5. Speaking Of: How Dark Is Social Mood Still?

So we know that one of the effects of negative social mood trends on pop culture, entertainment and film, is an increasing taste for horror genres and dark themes, particularly gore, violence and torture. All that certainly explains the timing of the release of A Serbian Film, which was previewed at South by Southwest earlier this spring and which is now opening to a very limited release here in the US.

Let me warn you up front. I read the entire synopsis via Wikipedia and watched the trailer of this film yesterday and it ruined my day. I am completely serious. It literally ruined my day. Proceed at your own risk.

No positions in stocks mentioned.

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