Broker Check

Sabermetrics and the Stock Market

| June 19, 2014

The game of baseball is a passion of mine – I love everything about it and what it represents……well, almost everything. Some of my earliest memories around the game were pouring over and analyzing player and team statistics. However, this relatively new concept of “sabermetrics” that dominates most every aspect of the game today makes me want to throw up on my shoes. And for some reason (my brain is a strange place much of the time), it dawned on me this morning that the nausea I feel around most sabermetric discussions is the same one I experience while watching some of the more popular financial news broadcasts out there today. Let me explain…..

For those unfamiliar with the term and its applications, sabermetrics is loosely defined (by me) as the use of an infinite amount of statistical data to measure and/or predict a player’s or team’s performance in baseball. Those that subscribe to its usefulness will adamantly defend its ability to better rank and predict a player’s value much more definitively than using traditional stats that have been around for a hundred years. Instead of simply ranking a player based on his ability to get on base vs. his peers, sabermetrics can allegedly tell us exactly how many more wins a team will achieve by having that player vs. a replacement. Sounds great, right?

In the investing world, we’ve taken alpha and beta and put them on steroids (pun intended) to manufacture endless new statistical measures designed to explain and predict what a stock or market index will do in the future. This is plastered all over the media and in advertising material. But there is one critical difference between the statistics used in the investment world vs. the baseball world – the ever present and mandatory disclosure that “past performance is not indicative of future results”. I propose that agents, general managers, and media personalities in baseball all be required to use this same disclosure when discussing the value of any particular player or team – especially when employing sabermetric analysis in all of its glory.

So why is it that the worlds of baseball and investing so closely align when it comes to the use of statistics in attempting to predict performance? For one, there is an IMMENSE amount of money involved with both – so it makes sense that those involved will take extraordinary measures to gain every advantage before making decisions. But in my opinion, what it really boils down to is this – we want to believe that we can control the uncontrollable and predict the unpredictable. And yes - stocks and baseball players share a common trait in that their future performances are by and large both uncontrollable and unpredictable – regardless of the amount of statistical analysis that was done ahead of time and regardless of what is conveyed by your favorite TV personalities or in your favorite print subscriptions. I am biting my tongue so hard right now it hurts (mainly as I am not an expert in slander law)……

Want a recent example? Look at the Red Sox this year and last. Many a sabermetrician picked the Red Sox to finish at the bottom of their own division in 2013……and they won the World Series. This off-season, many of the same prognosticators used their sabermetric models to predict the Red Sox were now the team to beat. Not surprisingly, the Red Sox are a game or 2 out of LAST place in their division as of this writing. What happened? “Past performance is not indicative of future results”.

I want to finish by emphatically stating that statistical analysis ABSOLUTELY has a place in your investment strategy (and in baseball). It is foolish to not take note of how a stock, sector, or asset class performed in past cycles. We use it every day – the same way I rely heavily upon statistics to draft my fantasy baseball team. Having said that, every one of our clients can attest to the fact that we flat out NEVER predict performance numbers when constructing a portfolio or discussing a particular investment. The reason for this is simple - I know that I cannot control or predict it no matter how hard I try – and I find it dishonest to insinuate otherwise. What I can do is to make sure that I truly understand the client’s objectives, construct a portfolio in line with those objectives, and take the emotion out of future investment decisions as much as possible (emotion in investing vs. team chemistry in baseball – sounds like a future post).

We go through performance numbers at the end of each year with every client – because those numbers are real and not assumed. Those are the numbers investors should care about……

To keep this rant compliant, please note that all opinions expressed in this material are my own and do not necessarily reflect the views of LPL Financial………

As always, to all of our clients, we thank you for your continued trust and confidence in Round Hill Wealth Management.

Thanks for listening,