Insight Line—August 20, 2007

An old adage suggests if a little does a little good, then a lot will do a lot of good. This, of course, may be excellent guidance under the right circumstances. But, if it’s information flows we’re talking about, well, then, I’m tempted to respond that too much of a good thing may be bad for you.

At times of increased capital market volatility, many investors believe they need more information to better understand, let alone predict, future market direction. I believe that most investors are, by nature, risk-averse and, therefore, are uncomfortable during times of increased uncertainty—whatever the cause. In order to find some level of confidence many investors develop and rely upon elaborate and sophisticated methodologies—models, if you will—in an attempt to quantify the fine line between certainty and uncertainty. While it is one thing for investors to set up mathematical models to forecast expected returns under multiple external scenarios, it is quite another to ascribe certainty to the outcome.

Markets and investing are inherently uncertain. That’s why I find it interesting that over the past month many market commentaries suggest the increased level of market volatility begins with the uncertainty faced by investors. Such commentary seemingly implies that as soon as the number of variables affecting the outcome of their investment decisions declines, investors’ confidence levels should rise. In other words, investors believe the quantity of information matters.

Though such an assumption seems logical, behavioral scientists suggest otherwise. In fact, these researchers would argue that beyond a certain point additional information may actually do little to improve an initial level of accuracy. Nassim Taleb, the author of The Black Swan, argues that, “The more information you give someone, the more hypotheses they will formulate along the way, and the worse off they will be. They see random noise and mistake it for information.”¹

Moreover, as the following oft-cited academic study supports, having more information does not necessarily imply a correct conclusion.

The study, done in 1965 and repeated in varying forms over the years, focused on the behavioral traits of clinical psychologists who received increasing amounts of background information on a number of pending, but undiagnosed, cases. Following a cursory examination of the data, the doctors indicated what they thought their chances were of arriving at the correct diagnosis for each case and then reassessed their confidence with each presentation of additional information. The surprising result—that the accuracy of their diagnoses did not increase proportionately to the amount of information—called into question the value of receiving additional information. In other words, more information did not result in a marked improvement in discerning the correct diagnosis.²

The implications in today’s investment climate are clear. If the researchers are correct, and I have little reason to think otherwise, once investors form an opinion they are more likely to accept confirming information rather than accept that the initial opinion may be wrong.

¹ Taleb, Nassim Nicholas, The Black Swan, Random House, New York, NY, ©2007, page 144.

² Taleb, Ibid, citing the 1965 study connected by Stuart Oskamp, page 144.

This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information in this report does not pertain to any Van Kampen product and is not a solicitation for any product.

Factors Driving the Economy

Economic Acceleration

Economic Deceleration

Latest Available Information
(as of 08/15/07

Employment
^{(Source: Bureau of Labor Statistics)}

Up

Down

The July 2007 employment data was a little rough around the edges. Granted, while the addition of 92,000 new payroll jobs pushed total payroll employment to a record level of 138.122 million, the year-over-year growth of 1.4 percent was the lowest since July 2004. Additionally, the rise in the unemployment rate in the household survey of only one-tenth of a percentage point to 4.6 percent was the result of the largest monthly gain of unemployed workers in almost a year. Lastly, the combination of falling hours worked and rising hourly pay warrants further attention in the months ahead as they are important components in the overall calculation of the gross domestic product (GDP). That said, I suggest the appropriate action on the table is to circle Up.

Personal Income
^{(Source: Bureau of Economic Analysis)}

Up

Down

June 2007’s personal income data, though rising less than forecast, was essentially in line with trend growth in previous months. The 0.4 percent increase moved the annualized total of $11.6 trillion to yet another record. Wage and salary totals, at $6.4 trillion, have never been higher. In an interesting development, the yearly benchmark revisions to the data going back to 2004 all but wiped out the widely reported negative savings rate of the last three years. All in all, I believe personal income data remains supportive of economic activity in the coming months. Please circle Up on the table.

Retail Sales
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

July 2007 retail sales data, much like the employment data, was a crosscurrent of information. The monthly total of $376 billion was slightly more than forecast. However, it is possible to argue that the number was held back by falling gasoline prices and lackluster auto and parts sales; both temporary factors. That said, the year-over-year trend at 3.2 percent is at the lower end of recent trends and therefore I am continuing to suggest the appropriate circle on the chart remains Down.

Durable Goods
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

Durable goods orders for June 2007 suggested moderate but continuing strength in the nation’s manufacturing sector. New orders, inventories, and unfilled orders all registered positive gains. If there is any negative to the report, it is that shipments and inventory building, when taken in combination, suggest little inventory build over the coming quarter as supplies on hand appear adequate. Therefore, I am leaving Down as the preferred circle of choice.

Inflation
^{(Source: Bureau of Labor Statistics)}

Low

High

Inflationary pressures remain evident but not elevated. The Federal Reserve’s preferred measure, Personal Consumption Expenditures ex-food and energy price changes, as of June 2007 rested at 1.9 percent year-over-year. Inflation, though within the acceptable range for some members of the Federal Open Market Committee (FOMC), has yet to demonstrate to some FOMC members its ability to remain within accepted targets. Therefore, in accordance with the FOMC’s elevated concerns, I suggest, but do not heartily support, circling High on the chart.

Government Spending
^{(Source: Congressional Budget Office, U.S. Treasury)}

$In

$Out

With only two months remaining in fiscal 2007 the U.S. federal budget prospects are the brightest in over six years. Early forecasts of a $400 billion deficit have proved wide of the mark as tax receipts, despite rising federal budgets, have far exceeded expectations. If history is to be any guide the federal budget deficit for fiscal 2007 may slightly top $150 billion. That said, the budget deficit does remain a feature on the investment horizon for months and years to come. As such, the federal government continues to stimulate economic activity with deficit expenditures thereby making the appropriate circle on the chart $In. That said, it is important to note the slowing rate of growth in government expenditures as a potential negative for economic growth in the quarters ahead.

Monetary Policy
^{(Source: Board of Governors, the Federal Reserve System)}

$In

$Out

The FOMC held the overnight inter-bank lending rate at 5.25 percent. Though I have maintained that a rate cut is appropriate in light of favorable inflation metrics, recent events in the nation’s credit markets have altered investors’ beliefs that a rate cut may be imminent. Therefore, please continue to circle $In.

Yield Curve
^{(Source: Bloomberg, LP)}

Positive

Negative

The difference between the three-month Treasury bill yield and the 10-year Treasury note yield was 46 basis points on August 15, 2007.
Please Circle Positive.

Gross Domestic Product
^{(Source: Bureau of Economic Analysis)}

Above

Below

The nation’s GDP in the second quarter recovered smartly from the 0.6 percent annualized growth in the first quarter. The annualized rate of 3.2 percent came about as government and business spending surged. Net exports were also a surprising source of strength and may factor into a forthcoming upward revision. Nevertheless, anecdotal evidence in the third quarter calls into question the sustainability of the last quarter’s growth. Housing and government spending do not appear to be as strong. Consumer and business spending, while not retreating from second quarter’s levels, show few signs of advancing. Exports appear to be the only bright spot on the horizon. Therefore, I continue positioning the appropriate circle as Below.