All Market Models Are Wrong But Some Are Useful

All Market Models Are Wrong But Some Are Useful

Posted April 23, 2021 by Ben Carlson

I was doing a little research into the relationship between wages and inflation this week and found a report from 1952 detailing the incomes of families in the United States in 1950.   There were nearly 40 million households in the U.S. in 1950. Just 3.3% of those households made $10k or more per year while 77% made less than $5k.  So you could talk all you want about candy bars selling for a nickel or houses selling for $7k back then but the main reason things were so much cheaper is because people made less money.1

People are very scared of inflation today but the trade-off with inflation is you typically see wage growth as well. Since 1950, prices are up around 1000% as measured by the CPI. But median household income is up more like 2500% in this time.  Wages aren’t growing as fast as many people would like in recent decades but they have still grown over the rate of inflation over the long-term. So I think some inflation could actually be good in the coming years if it is accompanied by higher wages.

These types of trade-offs are everywhere in the markets when you start looking.

Once I went down the wages and inflation rabbit hole I realized there were all sorts of other variables to consider. My list got quite long very quickly:

I also looked at economic growth, returns for housing, stocks, bonds and cash, earnings growth, interest rate levels and stock market valuations.

You can see the 1970s were a period with high growth in earnings, GDP and wages but inflation was out of control so that growth was a mirage. Then you had a period like the 1990s where the economy did well, wages were up, inflation was average and stocks went nuts. Wages actually outpaced inflation by a wide amount in the 2010s but those gains weren’t equally distributed.

While inflation and wages do have some sort of relationship, it’s not as clear-cut as you would think.

Once you begin looking at all of these variables you realize there are relationships here but caveats abound. There is no such thing as a “normal” market or economic environment. Each period is unique in its own way.

Markets and economies are constantly changing as are the inputs that make them up.

For example, Michael Mauboussin wrote an excellent research piece this month about the relationship between valuations and accounting methods that bears this out. Look at this chart of the percentage of companies in the U.S. stock market with negative earnings:

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https://awealthofcommonsense.com/2021/04/all-models-are-wrong-but-some-are-useful/