The primacy of the individual (aka the generalisation trap)

Macro trends

I blogged earlier today about the reported weak retail figures, though you might be forgiven for thinking that we're not in anything even approaching a spending recession if you walked down the always-packed Pitt Street Mall in Sydney. That's partly because I was considering the national picture rather that the state-by-state figures which tend to vary significantly.

Not dissimilarly, if I ever make reference to "wages growth of 3.2% in Australia", as sure as night follows day someone will comment that they have been made redundant or forced to take a pay cut, and therefore my quoted numbers are flawed. Again, that's because I'm considering the macro picture rather than the circumstances of each individual. 

I could instead say, "it's more likely that you got a 5% pay rise if you work in mining than if you work in manufacturing" but that would still be a generalisation. Economics tends to take this 'top down' approach of looking at figures in aggregate as the best-available mechanism for policies to be set, but it does have obvious flaws.

The Austrian School

The Austrian School of economics in the late 19th century instead preferred to concentrate on individuals and their own motivations for taking decisions, such as whether to go and spend money at the Pitt Street Westfield (or whatever the 19th century equivalent was - taking a tram to QVB shopping boutiques to buy a pocket watch?) or to save for a rainy day. After all, the aggregate figures that are quoted by economists are ultimately the result of many thousands of decisions taken by individuals. 

As the 20th century moved on, this idea of what Karl Marx called with disdain "the cult of the individual" gradually became the all-important philosophy in policy-making, culminating in 'Reaganomics' in the US and Maggie Thatcher's free market "loadsamoney" policies in the United Kingdom. Free market reform and laissez faire policies reigned.

The Austrian School of economics has come to be recognised as very important, in particular because its proponents correctly predicted the downfall of communism, suggesting that state-controlled policies would eventually fail because they failed to recognise the primacy of the individual.

Confidence in economics

The failings of mainstream economics are fairly well understood these days. I mean, check out the confidence that the Reserve Bank of Australia has in its own forecasts of, say, GDP growth. The RBA is only 90% confident of forecasting GDP of between ~0.5% and ~5.5% - a seemingly preposterous difference of 500bps!

In other words, even the Reserve Bank's own forecasts are as close to a guess as almost makes no difference. So, next time you hear someone confidently forecasting Australia's GDP growth, or the unemployment rate, or the inflation rate...you know better - they're guessing!

Source: RBA

The generalisation trap

The Austrian School therefore prefers to focus on the 'primacy of the individual', rather than making the sweeping assumptions of mainstream economics (such as Adam Smith's invisible hand theory which suggests that we always operate as rational profiteers). 

Investors can't escape the importance of this. The best run companies understand the granularity of growth and do not rely on broad generalisations. The press is awash with articles about stock markets booming by more than 17% through the 2013 financial year. Yet what if you had been heavily invested in resources stocks since late 2008? Poor dividend streams and slumping capital values. Ouch!

On the other hand, it you'd simply held on to shares in the major banks since the market nadir of 2009 you'd have generated fantastic dividend income, stunning capital growth and you'd be laughing all the way to ...erm...well, to the bank.

I'm back in London this week, and it's been fascinating to see how property market trends have played out since I was plying my accountancy trade here in 2001-2003. At that time, it seemed that almost every trendy young person I knew (and even my older brother who was not particularly young, nor, for that matter, trendy) was heading to the south-west of London - to Balham and Battersea, or Clapham with its awful nightclubs (I used to audit the Clapham Grand 'nitespot' - strewth, truly awful).

In spite of the small matters of a global financial crisis and a triple dip recession, if you'd bought the right property in those areas you could have achieved outstanding capital growth over the intervening years of well over 100%. Those twenty-somethings are now thirty-somethings with approximately 2.4 children (a small generalisation, that one) but they're hanging out in Clapham or nearby. Wine bars and trendy restaurants are now the order of the day rather than dismal nightclubs: it's the life cycle of a suburb.

There was a theory held by some back at that time that the old 'council flats' of the traditional working class East End would be outperforming investments, but in many areas that hasn't really played out (similar weak growth trends have occurred in north-east London). Prices have been capped and growth has often been very limited. 

Why? Well, at the risk of falling headlong into the generalisation trap, because the East End remains a lower demographic area, and it often simply cannot compete with the hot money which is flowing into the premium boroughs such as Kensington & Chelsea. Outside London, in many areas prices even remain below where they were in 2005.

It's a similar story in Australia. There are a few half-baked theories doing the rounds about a 'working from home revolution' and everyone selling up en masse to go and work from a home office in the countryside. Has it happened? Well, as a posh Sydneysider my social circle might not be representative of the nation, but to date I've not met a single person who has done so. 

What I have met are scores and scores of people in my age bracket who have bought medium-density dwellings in the inner/middle and beachside suburbs in Sydney, and plenty who have moved to the inner west to buy houses around Newtown, Stanmore and Erskineville. Immigrants to the country seem to me to be doing the same thing. Sydney dwellings prices are booming yet the cheapest sector of the Sydney market underperforms.

If you want to seriously outperform in property you need to drill down beyond city-wide prices to this level and identify the demographic trends that are actually playing out, and then find the right property types and locations which match the trends. It's seriously worrying when you see advice out there which suggests that buying any old property as long as it generates a positive cash-flow will do ("no viewing required!"), particularly in remote locations and distant outer suburbs. Terrifying, in fact.

Be smarter than that and recognise the primacy of the individual.