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Guest Post: Beware Of Extrapolating Trends

Tyler Durden's picture




 

Submitted by Charles Hugh Smith from Of Two Minds

Beware Of Extrapolating Trends

Extrapolating trends is exciting but misleading.

Manias, bubbles and "momentum investing" all rely on observing a trend and extrapolating it into the future. This is how we get "housing never goes down" and other trends which eventually run out of oxygen.

Consider this example of extrapolation. If you follow basketball at all, either your local high school or college teams or the pros, then you've seen a game start out with one team scoring a quick three baskets for 6 points while holding the other team scoreless, making it a 6 to 0 game.

If we extrapolate those first few moments of play, then we'd expect the score at the end of the game to be 200 to 0.

Let's say the first basket was scored in 60 seconds, the second one after another 30 seconds of play and the third (perhaps a steal) after only 15 seconds. If we extrapolate that timeline, then we soon reach the point where baskets are being scored in milliseconds, as the fourth basket is scored in only 7.5 seconds, the fifth in 3.75 seconds, and so on.

Let's turn from this admittedly absurd example to some real-world charts. The current stock market rally is supposedly based on rising corporate profits, which have rebounded smartly from the March 2009 lows. The Bulls' euphoric expectation of ever-rising stock valuations is based on the extrapolation of these profit trends.


But interestingly, non-financial corporate profits have already peaked and are turning down, while financial corporate profits have already hit the nose-bleed level that marked the last top.

Legions of China Bulls (i.e. true believers of the "China story") extrapolate China's spectacular GDP growth into the future. If we ponder this chart, we see that Japan also experienced a rapid rise in GDP in its boost phase, but that growth rate cannot continue on to the Moon and beyond.


Exactly how much farther China's GDP can run at this rate of expansion is unknown, but anyone betting on this trend continuing at its current trendline for years to come is basically betting on the basketball game's score ending up at 200 to 20.

A peculiarly gripping mania has led many to believe that U.S. healthcare costs can continue rising on its current trendline forever-- or at least until 2050 or so, which is politically the same as 2550. Once again, anyone who thinks sickcare costs can skyrocket by 6% to 11% annually while the nation's GDP is flat or negative (once Federal borrowing and spending are subtracted) is expecting the game to end with a score of 200 to 20.


Few seem to recognize any upper limits on consumer debt. The idea that this trend cannot be resumed strikes terror into the hearts of economists and politicos alike. What does the U.S. economy do for "growth" if this consumer debt trend rolls over and heads down?


All sorts of trends are being extrapolated to justify sky-high stock valuations, insane levels of government borrowing and complacent confidence in a permanent abundance of cheap energy--to name but a few.

The Fed has raced out and scored a few points in the Great Recession, and yet few analysts extrapolate its expanding balance sheet out a few years. Can the Fed really create $10 or $20 trillion in free money and use that to buy up the U.S. economy's impaired debt and unwanted Treasury bonds without any negative consequences?

Corporate profits have rebounded on the back of a declining U.S. dollar and an unprecedented explosion of Federal deficit spending. Yet SIFPs (standard-issue financial pundits) still expect corporate profits to rise steadily despite the fact that the underlying trends have reversed.

Healthcare costs are rising at a rate that leads to all sorts of 200-to-0 games: if the current trendline holds, then the average household's health insurance will cost $300,000 in today's dollars in a few years. Does anyone seriously believe this runaway expansion of healthcare is remotely sustainable?

As stock market Bulls are about to discover, the one thing we know about trends is that they do not continue on to the Moon as per extrapolation lines neatly drawn with a ruler. They flatten, reverse or crash.

 

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Tue, 03/29/2011 - 12:46 | 1113209 carbonmutant
carbonmutant's picture

Tulips...

Tue, 03/29/2011 - 13:11 | 1113303 Harlequin001
Harlequin001's picture

Nah, they'll never catch on...

Tue, 03/29/2011 - 14:58 | 1113744 YouBetYourLife
YouBetYourLife's picture

Ben won't be happy until it's threelips . . . fourlips . . .

Tue, 03/29/2011 - 15:51 | 1113962 nkktwotwozero
nkktwotwozero's picture

Treasuries...

Muni's....

TBTF's...

USDs...

Tue, 03/29/2011 - 12:46 | 1113214 John Law Lives
Tue, 03/29/2011 - 13:08 | 1113293 DosZap
DosZap's picture

On the Mortality issue, we spend untold amounts on Health Care, and yet the USA has the (may be off a tad), the distinction of being like #18 in life expectancy globally.(Yes, the Almighty USA).

In ALL the states with highest health care issues, the people are more obese, have the most diabetes per capita,health care issues, and lowest income levels compared to the rest of the states.

Why is this?, easy..............when you are borderline poverty level you are forced to eat the worst foods, and they are always the least expensive.

Tue, 03/29/2011 - 13:09 | 1113299 spinone
spinone's picture

Its because unlike other countries, we have for-profit healthcare.

Tue, 03/29/2011 - 13:33 | 1113379 traderjoe
traderjoe's picture

In collusion, partly through the revolving door of regulators/corporations, with the mega-agribusinesses...

Tue, 03/29/2011 - 13:48 | 1113450 ceilidh_trail
ceilidh_trail's picture

Uh, spinone- try spinning another. I have spent 30+ years in health care and will tell you flat out you are wrong. People who come to my unit are typically the sickest of the sick. Sometimes we work miracles, but many times we cannot- most of the time due to what these persons did/didn't do to keep their health prior to ever entering the health system. You think you can do a better job? Try lugging on a 500lb blob just for basic care such as bathing, turning, etc- let alone trying to get a deep line in someone who is so damn fat the needle isn't long enough to reach the vein (3" needle). Trauma- stupid people shooting/knifing/clubbing each other, idiot car crashes, electrocuted copper wire/plumbing thieves, blahblahblah... Smoking, drug/alcohol abuse, unprotected sex, poor diets leading to cardiovascular disease, on and on it goes. Lots of reasons for bad morbidity/mortality statistics in the USA, oftentimes these people croak before they ever touch the healthcare system. It's not so simple to just blame "greedy" providers. The blame is usually on the individual making stupid life altering choices...

Tue, 03/29/2011 - 14:06 | 1113533 Buckaroo Banzai
Buckaroo Banzai's picture

People make poor health choices in this country, and that's definitely their fault, but to be fair the entire system is stacked against them in this country. Big Pharma and Big Agriculture flat-out OWNS the CONgress, and in a demonic public-private partnership they literally produce mountains of poisonous shit that people actually voluntarily put in their bodies. Say's law--possibly the greatest single economic rule of thumb ever conceived-- states that supply always creates its own demand, and this is a perfect example of what happens when you jam a gigantic river of shit into the food distribution and morbidity-care delivery systems. People consume it.

Tue, 03/29/2011 - 15:10 | 1113784 Cvillian
Cvillian's picture

+1

Get a handle on fat kids and we're on our way to fixing this broken system. Probably starts with educating them that food pyramid, etc are horrible lies.

Tue, 03/29/2011 - 14:59 | 1113751 IQ 145
IQ 145's picture

 We're having an epidemic of "stupidosis".

Tue, 03/29/2011 - 17:30 | 1114490 wisefool
wisefool's picture

give them tobacco and they wont be fat. give them contraception and we'll get a novel. give them fiat currency and we will get pure comedy gold.

Tue, 03/29/2011 - 20:08 | 1115048 saulysw
saulysw's picture

See further the movie "idiocracy"

http://www.imdb.com/title/tt0387808/

See this as a good primer on the problem...

http://www.youtube.com/watch?v=PSROlfR7WTo

Tue, 03/29/2011 - 14:07 | 1113531 tmosley
tmosley's picture

No, it is because unlike other countries which have socialized health care, we have fascist health care.

http://mises.org/daily/4276

Tue, 03/29/2011 - 18:11 | 1114674 JW n FL
JW n FL's picture

60% of those monies will be spent with Private Health Care Providers.. Thats why there was a $5 Billion Dollar Lobby for Universal Coverage.. when technically we had universal health care.. based on the fact Hospitals have to see you when you are sick.. whether you can pay or not.

Tue, 03/29/2011 - 18:48 | 1114786 greenbear
greenbear's picture

Superb article. 

I hate allopathic medicine.  That system killed my mil.  She believed doctors without question and that was a fatal mistake.  Because of elevated "cancer markers" they sliced and burned her for years.  The story is too long to tell so fast forward to the end. They zapped her femur with radiation so many times it just snapped under her weight and voila she was bed-ridden.  Then she got an infection from a cathater and died.  Between the doctors and the markets TPTB stole everything she and her deceased husband had saved over a lifetime.  Then when it was all gone they managed to kill her. 

Written by Luke (himself a physician):

Luke 8:43 And a woman having an issue of blood twelve years, which had spent all her living upon physicians, neither could be healed of any,

Not much has changed in 2,000 years.

Tue, 03/29/2011 - 14:22 | 1113594 RafterManFMJ
RafterManFMJ's picture

Very valid point. Have thought the same for many years...adding a profit motive obfuscates and drives up costs, as you have so many regulations.  What really screwed health care was making it a 'free' bennie during WWII.

Tue, 03/29/2011 - 13:39 | 1113402 Bicycle Repairman
Bicycle Repairman's picture

"when you are borderline poverty level you are forced to eat the worst foods, and they are always the least expensive."

There is some correlation there.  Perhaps another correlation is people on the poverty border line are less intelligent.  In today's food market the consumer has to exercise more care to avoid dietary pitfalls.  In days of yore the leadership would recognize this deficiency and protect people from "predators".  No longer.  Darwin rules, everybody.

Tue, 03/29/2011 - 14:20 | 1113590 barbarika
barbarika's picture

"when you are borderline poverty level you are forced to eat the worst foods, and they are always the least expensive."

The expensive part is certainly not true. Organic steelcut oat is $1.19 a pound at the neighbouring grocery store. Bananas are 49 cents a pound. Seasonal fruits sometimes go under 80 cents a pound. The problem with borderline poor is lack of knowledge/lack of accessibility, or more likely plain old laziness. As a grad student for five years living on $1200 a month, and sending 500 of it back home, i managed to stay pretty healthy, and everyone in this country can. Problem is the entitlement mentality, and the tendency to blame the other for self created ills. If people are forced to face conequences of their actions early by cutting welfare, maybe there will be some improvement.

Tue, 03/29/2011 - 20:14 | 1115062 Beatscape
Beatscape's picture

+1.  I spent years in my youth living on eggs, bananas, peanut butter (high in protein), broccoli, water (no milk or juice), apples, canned tuna and cottage cheese.  No one forces poor people to eat lousy food--they do it because they don't think for themselves or know any better.  Sure, you can blame mind altering advertising if you like, but people have to accept responsibility for their own actions.  I watched the same TV commercials, but rarely ever ate fast food. Plus, everyone knows when they are getting overweight.  I have zero sympathy for corpulent fatsoes that fully realize they are way over the line and endangering their health. Our instant gratification society has bred an army of sick corpulent beasts.

Tue, 03/29/2011 - 14:47 | 1113699 ElvisDog
ElvisDog's picture

Oh, bullshit. You are not "forced to eat the worst foods". People don't eat Big Macs and KFC because it is the cheapest food around. You could make a spaghetti dinner for four for less than $6.00 (1 lb pasta ~ $1.49. 1 bottle spaghetti sauce ~ $2.49 1 lb broccoli $1.49) which is less than you can feed a family of four for at Burger King. People buy fast food because it is relatively cheap, is convenient (no cooking), and is loaded with fat, salt, and sugar.

Tue, 03/29/2011 - 16:02 | 1114009 nkktwotwozero
nkktwotwozero's picture

>You are not "forced to eat the worst foods".

It's heavily subsidized.

The unhealthiest lifestyles are the most heavily subsidized in the US.

Driving everywhere is subsidized by huge highway building programs.

Detached single family home (aka, feeding through) and car (detachable room) become the cocoons of a horrendously unhealthy life of sitting and eating unhealthy foods.

Such as beef and dairy products; which due to the way the USDA's subsidies are set up, receive the bulk of subsidies.

This may have made sense in another day and age, but today, it does not.

 

And then people wonder how nearly half of 45+ year olds are obese.

It's because the lifestyle they lead is hideously unhealthy, and very heavily subsidized.

Tue, 03/29/2011 - 15:52 | 1113966 nkktwotwozero
nkktwotwozero's picture

Because US is too much "Care" and not enough "Health".

Tue, 03/29/2011 - 12:48 | 1113218 redpill
redpill's picture

Chuck Norris can continue to kick ass exponentially

Tue, 03/29/2011 - 12:56 | 1113259 Sudden Debt
Sudden Debt's picture

And when he starts to cry, politicians turn honest.

 

Tue, 03/29/2011 - 12:59 | 1113270 WALLST8MY8BALL
WALLST8MY8BALL's picture

Chuck Norris' tears could cure AIDS , but Chuck Norris never cries!

Tue, 03/29/2011 - 13:10 | 1113302 Harlequin001
Harlequin001's picture

doesn't act either...

Tue, 03/29/2011 - 13:13 | 1113311 redpill
redpill's picture

Why in the world would he pretend to be someone else?

Wed, 03/30/2011 - 03:58 | 1116132 Harlequin001
Harlequin001's picture

because that's what they do in the movies isn't it?

Well some of them anyway.

some of them evidently aren't very good at it...

like Steven Siegal who only plays Steven Siegal, and Charles Bronson who only ever plays Charles Bronson.

and Ben Bernanke who only ever plays Santa Claus...

and Obama, who only ever plays a complete fucking idiot.

Tue, 03/29/2011 - 12:46 | 1113219 WALLST8MY8BALL
WALLST8MY8BALL's picture

 USA USA USA WE ARE # 1. In your  face Norway!

Tue, 03/29/2011 - 12:52 | 1113243 Horatio Beanblower
Tue, 03/29/2011 - 15:52 | 1113974 wisefool
wisefool's picture

Yeah, good on norway that gives out prises for peace before the Loki is elected. (saved the z)

Tue, 03/29/2011 - 12:52 | 1113233 Mr Anderson
Mr Anderson's picture

The household credit market debt outstanding chart should scare the hell out of everyone.

First time in history its trending down- 

Things are definitely getting better, thanks Ben

Tue, 03/29/2011 - 13:14 | 1113308 Harlequin001
Harlequin001's picture

bullish, definately...

Tue, 03/29/2011 - 12:53 | 1113238 HelluvaEngineer
HelluvaEngineer's picture

Anyone getting a funny feeling this market's gonna sell off at the end of the day (again?)

Tue, 03/29/2011 - 12:51 | 1113240 DrDre
DrDre's picture

 

Great point. People just do not seem to understand the implications of extrapolation, or chose to ignore them. Perhaps it is a tangible sign of how bad the education system is?

When analysts say equities are cheap based on the most recent year's earnings, they are implicitly extrapolating 2010's unudual growth rate permanently into the future. 

We live in a world where lemming thrive and prosper. Extrapolation is their weapon.

 

 

Tue, 03/29/2011 - 13:07 | 1113291 NidStyles
NidStyles's picture

Rather than deriding them, I prefer to try and educate them. I do believe a lot of them are interested in learning after their lives were nearly wiped out in the last debacle.

Tue, 03/29/2011 - 20:00 | 1115027 suldog
suldog's picture

Outstanding vids on compounding, extrapolation ... if you haven't already seen them.

http://www.youtube.com/watch?v=F-QA2rkpBSY 

Tue, 03/29/2011 - 12:58 | 1113258 RobotTrader
RobotTrader's picture

Lazlo's view of stocks:

Tue, 03/29/2011 - 13:18 | 1113323 Harlequin001
Harlequin001's picture

What is Kermit up to these days, haven't seem him for years...

Not since the Muppet's, which was excruciatingly funny...

and a sight more interesting than CNBC...

Tue, 03/29/2011 - 13:29 | 1113368 John Law Lives
John Law Lives's picture

Kermit looks happy in this photo.  Who wouldn't be?

http://movies.msn.com/celebrities/celebrity-photos/kermit-the-frog.1/?ga...

Tue, 03/29/2011 - 13:50 | 1113462 ceilidh_trail
ceilidh_trail's picture

+500

Tue, 03/29/2011 - 14:09 | 1113536 web bot
web bot's picture

Ever since Ernie and Bert came out of the closet and Cookie Monster became Veggie Monster... he's been on meds... no wonder in this #uckin crazy world... we're even giving the Koolaid to kids now...

Tue, 03/29/2011 - 14:38 | 1113656 Josh Randall
Josh Randall's picture

Exactly - that Ruler theory of his had me RFLMAO. How many of his Teflon Twenty do you own ? 

Tue, 03/29/2011 - 12:59 | 1113271 Dinghy Dumper
Dinghy Dumper's picture

General phenomenon - any process that relies on F(x) = exp(x) and at some level/ultimately connects to mass & energy flow in a system will first seem to grow without bounds, then become chaotic and eventually catastrophically fail and crash.

True for drive shafts in engines, nuclear reactions, tumor growth in cancer, climate change and - of course - financial markets.

Enjoy the ride !

PS: Also true for the number of comments posted to any new Zero Hedge article

;-)

 

Tue, 03/29/2011 - 13:35 | 1113388 traderjoe
traderjoe's picture

The fundamental flaw of the "science" of economics is relying on infinite growth (a compounding growth curve). The bullshit science of economics, meet the laws of thermodynamics. 

Tue, 03/29/2011 - 16:46 | 1114303 css1971
css1971's picture

NOOOOOOOOOOO! The Singularity WILL happen!!!!

 

This is one of the reasons I despise banks, politicians and economists (oh and "futurologists".. WTF?). They are basing everything on extrapolating an infinitely expanding exponential function. Fucking muppets should be either sweeping streets or breaking rocks.

 

Tue, 03/29/2011 - 13:05 | 1113282 LeftCoastRefugee
LeftCoastRefugee's picture

lalalalalalala.....Can't hear you, market only goes up.....

Tue, 03/29/2011 - 13:04 | 1113283 Guarded Pessimist
Guarded Pessimist's picture

I am looking forward to Richard Heinberg's new book coming out soon called The End Of Growth.

I think we're pretty much there.

http://richardheinberg.com/bookshelf/the-end-of-growth-book

Tue, 03/29/2011 - 13:18 | 1113332 Harlequin001
Harlequin001's picture

It happened in 1999, so he's 10 years to late already...

everything since is just pure accounting fraud...

Tue, 03/29/2011 - 13:06 | 1113287 Guarded Pessimist
Guarded Pessimist's picture

I am looking forward to Richard Heinberg's new book coming out soon called The End Of Growth.

I think we're pretty much there.

http://richardheinberg.com/bookshelf/the-end-of-growth-book

Tue, 03/29/2011 - 13:19 | 1113336 Harlequin001
Harlequin001's picture

dito...

Tue, 03/29/2011 - 13:10 | 1113296 williambanzai7
williambanzai7's picture

Everyone living beyond their means, that is the maniac mantra.

Tue, 03/29/2011 - 13:09 | 1113298 ItFarmer
ItFarmer's picture

be happy bay Ivorians Bond

chart:

http://postimage.org/image/u33ahwp0/

USD 2032 is trading at bid/ask 39.56 / 40.46

http://www.youtube.com/watch?v=sWpiWaAkQGU

 

Tue, 03/29/2011 - 13:17 | 1113317 LawsofPhysics
LawsofPhysics's picture

Bahhahahahahaha!  Thermodynamics is a bitch. Hey at least we can still make money on the way down.  Better just be careful what you call money as all paper becomes bid-less.  Bahhahahahahaha!

Tue, 03/29/2011 - 13:15 | 1113319 brian0918
brian0918's picture

"What does the U.S. economy do for "growth" if this consumer debt trend rolls over and heads down"

But why should it? What fundamentals about the US economy have changed - or are even possible to change for the better - to cause consumer debt to decrease? You cannot just say "this spike can't rise forever" and pretend that you've said something insightful. So long as interest rates remain low, foreigners continue to lend us money, and consumers continue to spend and not save or pay down debt, the consumer debt will continue to rise, as will the interest on that debt.

Tue, 03/29/2011 - 13:19 | 1113339 LawsofPhysics
LawsofPhysics's picture

"So long as interest rates remain low, foreigners continue to lend us money,"   So all foreigners are stupid?  I don't lend capital or invest capital without a reasonable return.  But wait, then you say the interest on the debt is rising?  Contradictions abound.  Perhaps this is what needs to be brought into the light.  Exactly who (the vampire squid) is "earning" all this interest?  Crash the system now so that compensation can return to those who are actually worth a shit.

Wed, 03/30/2011 - 09:30 | 1116547 brian0918
brian0918's picture

You misunderstood me. I agree that they won't lend to us forever. My point was that the OP is not looking at fundamentals, and is just looking at a chart and naysaying the extrapolation. In the same vein, he might look at a chart of a plummeting stock, and just say, "well, it can't keep going down forever. If it starts to rise, then what!" But why should it rise if the business is failing? While his statement is true, it doesn't offer any insight, and does not even begin to examine the fundamentals.

Tue, 03/29/2011 - 13:27 | 1113362 Johnny Lawrence
Johnny Lawrence's picture

Manias, bubbles and "momentum investing" all rely on observing a trend and extrapolating it into the future.

This is precisely what you're seeing on the retail side of brokerage firms, particularly when it comes to forecasting earnings growth.  You're getting a lot of the "companies know how to manage their costs better than ever" mentality.  And as a result, all the big brokerage firms are saying the market is still undervalued based on forward P/Es.

Tue, 03/29/2011 - 13:48 | 1113371 DiverCity
DiverCity's picture

Can the Fed really create $10 or $20 trillion in free money and use that to buy up the U.S. economy's impaired debt and unwanted Treasury bonds without any negative consequences?

 Absolutely, at least according to the neo-chartalists!

Tue, 03/29/2011 - 13:30 | 1113375 Implicit simplicit
Implicit simplicit's picture

Green shoots turning into green shit faster than a newborn with diarrhea. Pass the grey poupon pleas;,oh wait better make it the french's-gotta save.

Tue, 03/29/2011 - 13:36 | 1113390 Frank N. Beans
Frank N. Beans's picture

a timely article, since i believe corp profits to be released in a couple weeks will be lower than expected, and then maybe even POMO won't save the stock market; if POMO/QE2 does save the stock market, you will see P/Es rising absurdly.

 

Tue, 03/29/2011 - 13:37 | 1113394 jkruffin
jkruffin's picture

So, the last bubble took 7 years to pop, and this one is going to pop in less than 3 yrs. Simply amazing...

Tue, 03/29/2011 - 13:41 | 1113411 unclebigs
unclebigs's picture

Why is trend-line forecasting bogus for everything except Gold and Silver?  LMFAO!!!!

 

Tue, 03/29/2011 - 13:51 | 1113457 d00daa
d00daa's picture

Who exactly is making that argument?

Tue, 03/29/2011 - 14:34 | 1113441 gkm
gkm's picture

What the hell does this even mean "beware of extrapolating trends"?  Of course you extrapolate trends until the extrapolation doesn't fit in which case the trend is broken.  A trend is a trend until it isn't.  

Let's see:  would it have been better to extrapolate the trend on those charts eariler or say never?  This guy's an idiot.

Note to TD:  Sometimes the shit you don't post is as important as the shit that you do - if you catch my drift.

Tue, 03/29/2011 - 13:58 | 1113485 koot
koot's picture

Mr. Smith:  As long as anyones understanding cost or price basis remains the US dollar, all questions or analysis remain fallacious.  Ask first when or to what degree the US dollars remains World Reserve Currency, then ask or ponder subject issues.  Reasoning of any solution or logical outcome requires a firm and solid currency basis first and foremost, otherwise any percieved outcome will be wrong.

Tue, 03/29/2011 - 15:15 | 1113805 Abe Froman the ...
Abe Froman the Sausage King's picture

beware of anyone saying "for the foreseeable future"

Tue, 03/29/2011 - 19:24 | 1114912 tom a taxpayer
tom a taxpayer's picture

CHS - Thank you for the insights on exponeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeeential growth. Sobering.

Wed, 03/30/2011 - 00:20 | 1115860 Leo Kolivakis
Leo Kolivakis's picture

"permanent abundance of cheap energy..."

Solar baby, solar!!!

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