Is more choice better? Ten years ago the answer seemed obvious: Yes. Now the conventional wisdom is the opposite: lots of choice makes people less likely to choose anything, and less happy when they do choose.

The most famous supporting evidence is an experiment conducted by two psychologists, Mark Lepper and Sheena Iyengar. They set up a jam-tasting stall in a posh supermarket in California. Sometimes they offered six varieties of jam, at other times 24; jam tasters were then offered a voucher to buy jam at a discount.

The bigger display attracted more customers but very few of them actually bought jam. The display that offered less choice made many more sales – in fact, only 3 per cent of jam tasters at the 24-flavour stand used their discount voucher, versus 30 per cent at the six-flavour stand. This is an astonishingly strong effect – and utterly counter to mainstream economic theory.

One practical response to such experiments is that choice can be a good thing overall even if it does discourage us. I may find the choice between Robertson’s jam and Wilkin and Sons’ jam irritating and of no practical consequence to me, but you can bet that it has consequences for the two companies. We are often offered an apparently pointless choice between two equally good products, not appreciating that they are only good because we have been offered the choice.

The counter-argument was once put in a sketch about TV deregulation by Stephen Fry and Hugh Laurie: a waiter whisks away silver cutlery from a politician responsible for the proliferation of channels before dumping a sackful of plastic coffee stirrers in his lap. “They may be complete crap, but you’ve got choice, haven’t you?” Funny, but Fry and Laurie had it backwards. Zero choice is the fastest route to low quality.

But a more fundamental objection to the “choice is bad” thesis is that the psychological effect may not actually exist at all. It is hard to find much evidence that retailers are ferociously simplifying their offerings in an effort to boost sales. Starbucks boasts about its “87,000 drink combinations”; supermarkets are packed with options. This suggests that “choice demotivates” is not a universal human truth, but an effect that emerges under special circumstances.

Benjamin Scheibehenne, a psychologist at the University of Basel, was thinking along these lines when he decided (with Peter Todd and, later, Rainer Greifeneder) to design a range of experiments to figure out when choice demotivates, and when it does not.

But a curious thing happened almost immediately. They began by trying to replicate some classic experiments – such as the jam study, and a similar one with luxury chocolates. They couldn’t find any sign of the “choice is bad” effect. Neither the original Lepper-Iyengar experiments nor the new study appears to be at fault: the results are just different and we don’t know why.

After designing 10 different experiments in which participants were asked to make a choice, and finding very little evidence that variety caused any problems, Scheibehenne and his colleagues tried to assemble all the studies, published and unpublished, of the effect.

The average of all these studies suggests that offering lots of extra choices seems to make no important difference either way. There seem to be circumstances where choice is counterproductive but, despite looking hard for them, we don’t yet know much about what they are. Overall, says Scheibehenne: “If you did one of these studies tomorrow, the most probable result would be no effect.” Perhaps choice is not as paradoxical as some psychologists have come to believe. One way or another, we seem to be able to cope with it.

By Emily Kaiser and Nancy Waitz - Analysis

WASHINGTON (Reuters) - The U.S. government is having a tough time guesstimating how many small businesses failed in this recession, casting doubt on the reliability of vital data on employment and economic growth.

The formula the U.S. Labor Department designed to help it deliver timely, thorough monthly employment reports broke down in the heat of the financial crisis, miscounting the number of jobs by an estimated 824,000 in the year through March.

The most likely culprit is the so-called "birth-death" model, which the Labor Department uses to estimate how many companies were created or destroyed.

That model appears to have misjudged how many companies went out of business during the recession, meaning the labor market was even weaker than initially thought when President Barack Obama took office in January. More recent figures may still be underestimating job losses now, but it will be many months before the Labor Department is certain.

One characteristic of this recession is that it has hit small businesses especially hard, driving down demand and choking off vital sources of credit at the same time.

Obama's administration is scrambling to try to prop up small business -- it hosted a summit on that topic on Wednesday -- because those companies are essential to bringing the jobless rate down from its current 10.2 percent, having accounted for the lion's share of new job growth in recent years.

Government data has difficulty gauging the health of smaller firms because there are simply too many of them, leaving officials to rely on surveys and models that are hit and miss.

Jan Hatzius, an economist at Goldman Sachs in New York, thinks that is distorting not only the employment data, but also figures for retail sales, durable goods and even the biggest economic indicator of all -- gross domestic product.

"Our conclusion is that if small firms aren't captured well in the advance GDP data, the economy may be growing less quickly than suggested by the recent official data," he wrote in a recent note to clients.

Recent data has suggested the economy grew at a somewhat slower pace in the third quarter than the 3.5 percent rate the government initially estimated, and many economists think the figure will be revised down later this month.

Because of problems tracking small firms, Hatzius thinks the figure will eventually be revised down much more sharply, perhaps by as much 2 percentage points. But this could take years.

Government statisticians always are in a tug-of-war between trying to provide economic data quickly enough to be useful for policy makers -- and investors -- and ensuring its accuracy.

The task became even trickier during this downturn because the economy suffered such a swift and severe slump that the data struggled to keep up.

BIRTHS, DEATHS AND BREAKDOWNS

Olsson's Books & Records is one casualty of the recession. It filed for Chapter 7 bankruptcy liquidation last year, closing its five stores in the Washington area. At its height, the chain boasted nine bookstores, with some 200 employees.

Terence McCann, who was a business manager at Olsson's for 20 years, said it just got "harder and harder to compete every year."

In filing for liquidation, the company blamed low cash reserves, and an inability to renegotiate current leases, along with a continuing weak retail economy and plummeting music sales -- common ailments among small businesses.

Indeed, 43,546 businesses filed for bankruptcy in 2008, the highest tally since 1998, and the pace has picked up this year, according to data from the American Bankruptcy Institute.

In the second quarter of 2009, the most recent data available, 16,014 businesses filed for bankruptcy, up from 14,319 in the previous three-month period and the highest mark in 16 years.

The Labor Department simply can't catch all those failures fast enough to compile its monthly employment reports, which are normally released on the first Friday after the end of the month. So it must make an educated guess.

Each month, the department surveys about 160,000 firms to get a sense of how many jobs were added or cut. It also uses the "birth-death" model to try to estimate out how many companies opened or closed.

Once a year, the department looks at unemployment insurance tax records to get a more accurate picture of how many people were employed, and matches that up with its own data. Each February, it tries to reconcile these differences by releasing a "benchmark revision".

Normally, the discrepancy is modest. This coming February, it is likely to be about 824,000, according to the Labor Department's preliminary estimate last month. That would mean instead of about 7.2 million jobs lost since the start of the recession in December 2007, there were more like 8 million.

"Preliminary research indicated that a big portion of that was a result of a breakdown in the birth-death model," said Chris Manning, the department's benchmark branch chief.

Until this recession, the birth-death model had a track record of performing well regardless of whether the economy was growing or shrinking.

Manning said his department was still trying to figure out what went awry this time. One possibility is that the model was not sensitive enough to the credit crunch, which choked off borrowing and pushed many companies into bankruptcy.

"We're researching ways to better understand the limitations of the model, in particular when it comes to responding to economic shocks," he said.

One change under consideration is plugging data into the model more often, perhaps quarterly instead of once a year, so that discrepancies would be apparent sooner.

If the department decides on any changes in the next couple of months, it will spell them out in February when it releases the annual benchmark revisions, Manning said.

Are you still the best owner of your assets?

As companies rethink their portfolios for the post-crisis world, they should ask themselves if they are still the best owners of their assets.

As the post-crisis thoughts of executives turn to mergers, acquisitions, and disposals, the familiar idea of “best owner” takes on renewed urgency. Discerning readers will be well aware that best owners are those companies whose distinctive characteristics enable them to create more value in a given business than other potential owners could. But the pace of rapid recovery in equity market valuations may be causing some executives to worry too much about being preempted by better-prepared competitors and too little about acquiring businesses where they themselves would hold a distinct advantage.

The risk is considerable. Reactivating deals that were put on hold may be unwise in some industries where fundamental changes during the crisis have weakened the competitive position of deal targets or hurt the structural attractiveness of their markets. Companies may also discover that they have lost competitive advantage in businesses they already own. Moreover, boards and management teams that assess the fundamental attractiveness of their potential acquisitions and disposals solely by growth and returns increase the likelihood that they will enrich only the sellers of the businesses they buy—or the buyers of the businesses they sell.

If a board and management team want to create the most value for their own shareholders, they must be clear about how their company will add more value to a business than other potential owners can. If that isn’t the case, the company might best serve the shareholders’ interests by selling the business—or by not buying it in the first place.

What makes a better owner?

In reality, we can never know who the very best owner of a business might be; we can only know who is probably the better owner among competing alternatives. A better owner could be a larger company, a private-equity firm, a sovereign-wealth fund, or a family. It could also be an independent public company listed on a stock exchange, a mutual (owned by its customers), or even a government- or employee-owned entity. As better owners, each of these types of companies may add value to a business in a number of ways.

Valuable linkages with other businesses

The most straightforward way that owners add value is through the links they can offer to other businesses they own, especially when such links are unique. Suppose, for instance, that a mining company has the rights to develop a coal field in a remote location far from any rail lines or other infrastructure, except for those built by another mining company, which already operates a coal mine just ten miles away. The second mining company might well be the better owner because its incremental costs to develop the mine would be lower than the first company’s. It could afford to purchase the undeveloped mine at a higher price and still earn an attractive return on capital.

These unique links can occur across the value chain, from R&D and manufacturing to distribution and sales. A large pharmaceutical company with an experienced oncology sales force might, for example, be the best owner of a small pharmaceutical company with a promising new oncology drug but no sales force or commercialization capacity.

In most cases, these linkages (and the value they create) are not unique to a single potential owner. IBM, for example, has successfully acquired dozens of small software companies to take advantage of the power of its global sales force. IBM as an owner was better able to sell the products globally than the previous owners were. Other companies, such as Oracle or SAP, may also have been better owners; ultimately, the best depends on both the theoretical potential—the specific matches of products and sales forces—and the effectiveness of postacquisition merger management.

Distinctive skills

Better owners may also have distinctive and replicable functional or managerial skills,¹ which can be found anywhere in the business system, from product development to manufacturing processes to sales and marketing. The skill set has to be a driver of success in the industry, however. A company with great manufacturing skills, for example, probably wouldn’t be a better owner of a consumer-packaged-goods business, because manufacturing costs aren’t large enough to affect its competitive position.

In contrast, distinctive skills in developing and marketing brands often make a packaged-goods company a better owner. Take P&G, which as of 2009 had 20 brands with over $500 million in net sales and 23 with over $1 billion, all spread across a range of product categories, including laundry, beauty products, pet food, and diapers. Almost all of the billion-dollar brands rank first or second in their respective markets. What’s special about P&G is that it developed these brands in different ways. Some, such as Tide and Crest, have been P&G brands for decades. Others, including Gillette and Oral-B, were acquired during the past ten years, while a number, such as Febreze and Swiffer, were developed from scratch. As a group, sales of these brands grew by 11 percent a year, on average, from 2001 through 2009.

Better governance

Owners can also add value through better governance of a business, without necessarily having a hands-on role in its day-to-day operations. Better governance refers to the way a company’s owners interact with the management team to create the greatest possible long-term value—perhaps the way the owners appoint managers, structure their incentives, or challenge them on strategy. The best-performing private-equity firms excel at governance—giving them a crucial advantage over those that rely heavily on financial leverage. Indeed, prior McKinsey analysis found that in almost two-thirds of the transactions of the top-quartile funds we examined, improving the operating performance of a company relative to its peers created more value than financial leverage or good timing did.²

Better governance is a key source of this outperformance. Private-equity firms don’t always have the time or skills to run their portfolio companies on a day-to-day basis, but they govern these companies very differently from the way listed companies do. Typically, private-equity firms introduce a stronger performance culture and are quick to bring in new managers when necessary. In addition, they encourage managers to abandon sacred cows and give those managers leeway to focus on improvements over a five-year horizon rather than the typical one-year time line common among listed companies. Private-equity directors also spend, on average, nearly three times as many days on their roles than directors at public companies do, and they spend most of those days on strategy and performance management rather than compliance and risk avoidance.³

Better insight or foresight

Companies that have insights into how a market or industry will evolve may be better owners of businesses that don’t even exist yet, if they can use those insights to innovate and expand existing businesses or to develop new ones. In the late 1990s, for example, Intuit noticed that many small businesses were using its Quicken software, originally designed to help individual consumers manage their personal finances. That observation led to an important insight: most accounting software was too complex for small-business owners. So Intuit designed a new product for them and within two years had claimed 80 percent of this burgeoning market.

A decade earlier, the US oil and natural gas concern Williams Companies had the foresight to see that fiber-optic networks would be the future of communications. But unlike other companies that anticipated the shift, Williams had an additional insight—and a key advantage: fiber-optic cable could be installed in its decommissioned oil and gas pipelines at a fraction of the cost its competitors would have to pay for comparable infrastructure. By combining its own network with those it acquired from other companies that had fiber-optic networks, Williams eventually gained control of 11,000 miles of cable and could send digital signals and natural gas from one end of the country to the other.

Williams’s insight, combined with its pipeline infrastructure, made it a good or best owner of this network in the emerging digital-communications industry. Williams also reduced its stake in fiber-optic cable at the right time—when prices were highly inflated: it sold most of its telecommunications business in 1994 for $2.5 billion.

Distinctive access to talent, capital, or relationships

This category applies primarily to companies in emerging markets, where running a business is complicated by inherently smaller pools of managerial talent, underdeveloped capital markets, and high levels of government involvement in business as customers, suppliers, and regulators. In these markets, diversified conglomerates, such as Tata and Reliance in India and Samsung and Hyundai in South Korea, can be better owners because their size, stability, and relatively abundant opportunities make them more attractive employers and because they have better access to capital or distinctive relationships with governments.

The best-owner life cycle

Better ownership is not permanent or static but rather can change over the life cycle of a business. Too many companies don’t recognize that even if their own distinctive capabilities remain the same, the needs of a business naturally change as it matures and the industry it competes in changes.

Typically, a business’s founders are its first best owners. Their entrepreneurial drive, passion, and commitment to the business are necessary to get the company off the ground. As it grows and requires larger investments, a better owner may be a venture capital firm that specializes in helping new companies grow by providing capital, improving governance, and enlisting professional managers to handle the complexities and risks of scaling up an organization. Eventually, the venture capital firm may need to take the company public, selling shares to a range of investors to finance further growth. As the public company grows, it might find that it can no longer compete with larger corporations because, say, it needs global distribution capabilities far beyond what it can build in a reasonable amount of time. It may thus sell itself to a larger company that’s the better owner because of an existing global distribution network, thereby becoming a product line within a division of the larger company.

As the division’s market matures, the larger company may decide to focus on faster-growing businesses. In this case, it might sell its division to a private-equity firm—a better owner if the firm can eliminate corporate overhead that’s inconsistent with the business’s slower growth and thereby leave the division with a leaner cost structure. Once the restructuring is done, the private-equity firm can sell the division to yet another better owner: a large company that specializes in running slow-growth brands.

Managerial implications

The best-owner life cycle means that executives must continually seek out new acquisitions for which their companies could be the best owner while at the same time divesting businesses for which they no longer are. Since the best owner for businesses constantly changes, any corporation, large or small, should acquire and dispose of them regularly. Indeed, companies that do so generally outperform those that do not.⁴

For acquisitions, applying the best-owner principle often leads acquirers toward targets very different from those that traditional target-screening approaches might uncover. Traditional ones often focus on targets that perform well financially and are somehow related to the acquirer’s business lines. But through the best-owner lens, such characteristics might have little or no importance. It might be better, for instance, to seek out a financially weak company that has great potential for improvement, especially if the acquirer has proven performance-improvement expertise. Or it might be better to focus attention on tangible opportunities to cut costs or on the existence of common customers than on vague notions such as how related the target may be to the acquirer.

Keeping the best-owner principle front and center can also help with negotiations for an acquisition by keeping managers focused on what the target is worth specifically to their own company—as well as to other bidders. Many managers err in M&A by estimating only an acquisition’s value to their own company. Because they are unaware of the target’s value to other potential better owners—or how high those other owners might be willing to bid—they get lulled into conducting negotiations right up to their breakeven point. Of course the closer they get to it, the less value the deal would create for their own shareholders. Instead of asking how much they can pay, they should be asking what’s the least they need to pay to win the deal and create the most value.

Consider the example of an Asian company that was bidding against a private-equity firm to purchase a European contract pharmaceutical manufacturer. The Asian company estimated the target’s value to itself and also to the private-equity firm, which could add value by reducing overhead costs and attracting customers that hadn’t used the target’s services because it was owned by a competitor. The Asian company estimated that the contract company was worth $96 million to the private-equity firm.

The Asian company could make the same overhead cost reductions and add similar customers—but on top of this, it could move some of the manufacturing to its lower-cost plants. As a result, the target’s value to the Asian company was $120 million, making it the best owner and enabling it to pay a higher price than the private-equity firm would, while still allowing it to capture significant value. As a side note, the value of the target to its European parent was only $80 million.

Knowing the relative values, the Asian company could afford to bid, say, $100 million, pushing out the private-equity firm and gaining $20 million in potential value creation. The Asian company could further increase its share of the value to be captured, by announcing plans to enter the business even without making the acquisition. If the seller and the private-equity firm were convinced, they would have to reduce their estimates of the target’s value, and the Asian company could reduce its bid, capturing more value still.

For divestitures, including both sales and spin-offs, the best-owner principle allows managers to examine how the needs of the businesses they own may have evolved in different directions. For example, most pharmaceutical companies grew up as parts of diversified chemical companies because the basic manufacturing and research requirements were the same. But as the two industries specialized, their research, manufacturing, and commercial requirements diverged so much that they became distant cousins rather than sisters.

Today, running a profitable commodity chemical company demands scale, operating efficiency, and the ability to manage costs and capital expenditures. But creating value in a pharmaceutical company requires a deep R&D pipeline and large local sales forces, as well as specialized expertise in areas such as the regulatory-approval process and dealing with large public and private purchasers. While having both kinds of businesses under one owner made complete sense 50 years ago, it no longer does. That is why nearly all former chemical and pharmaceutical combines have split up over the past three decades; Zeneca, for example, separated from ICI in 1993, and Clariant and Sandoz parted ways in 1995.

Executives may worry that divestitures are seen as an admission of corporate failure or as a consequence of a company’s relatively small size. Yet the research shows that stock markets consistently react positively to divestitures—both sales and spin-offs.⁵ Research has also shown that spun-off businesses tend to increase their profit margins by one-third during the three years after the completion of the transaction.⁶

In my colleague Michael Mauboussin’s terrific new book, Think Twice1, the opening chapter tells the story of Big Brown, the super looking colt who’d won such impressive victories in the Kentucky Derby and the Preakness, the first two legs of racing’s Triple Crown. This is a story with a lesson that directly relates to investing, and to understanding the kind of recovery that appears to be getting underway in the U.S. economy.

After winning all 5 of his starts by a combined total of almost 40 lengths, Big Brown was a 3-10 favorite to win the Belmont Stakes and become the first horse in 30 years to win the Triple Crown. Those odds indicated the “wisdom of crowds” putting a 77% probability on Big Brown’s winning the race and making horse racing history. Part of that was right: he did make horse racing history — by being the only horse to win the first two legs of the Triple Crown and finish last in the Belmont. That so many were so sure of Big Brown’s success was due to a common analytical error that manifests itself in investing as well as horse racing. That error is the neglect of base rates. Psychologists call it the “inside” view, in contrast to the “outside” view. As Michael explains in his book:

The inside view considers a problem by focusing on the specific task and by using information that is close at hand. The outside view…asks if there are similar situations that can provide a statistical basis for making a decision. The outside view wants to know if others have faced comparable problems, and if so, what happened. It’s an unnatural way to think because it forces people to set aside the information they have gathered.

In the case of Big Brown, taking the outside view would be to see how many horses in the past had won the first two legs of the Triple Crown and then went on to win the third. The inside view focused on Big Brown, his history, the competition he faced, the tracks he ran on and their condition, his time between races, and so on.

The outside view revealed that 29 horses had won the first two races of the Triple Crown in the 130 years it had been run, with 11 of those horses going on to win the third race. Parsing the data a little more finely showed a remarkable divergence in winning percentages. Before 1950, 8 of the 9 horses that had a shot at the Triple Crown won it. After 1950, only 3 of 20 were successful. Moreover, when Big Brown’s speed ratings were compared to the most recent 6 Triple Crown contenders (and not just to his competition in the race), he was the slowest by a wide margin. If those who were betting on the Belmont had used the outside view instead of the inside view, no one would have believed what everyone did believe, that Big Brown had a nearly 80% chance to win the Belmont.

Investors are faced with these sorts of problems constantly: if I put my money in bonds now, what rate of return should I expect over the next 5 or 10 years? What is the outlook for stocks over the next 12 months? What are the chances of a significant rise in inflation over the next few years? What kind of economic recovery will we have? Should I fire my active money manager and replace him with a passive index product? What are the chances we have a “double-dip” recession? And on and on. Faced with these sorts of questions, most people default to the inside view, and then augment its flaws with the usual assortment of behavioral biases long known to psychologists: they anchor on the most recent experience, they assume instances are representative of deeper patterns, they give more weight to vivid examples or dramatic outcomes, they place twice the weight on a dollar lost as on a dollar gained, etc.

The financial crisis that is now abating has created a near perfect environment for the admixture of all of the above, and that is perhaps why what Nobel winning economist Ken Arrow called the “clouds of vagueness” seem particularly thick and forbidding just now. Taking the outside view on some of the issues facing investors won’t make an inherently unknowable future predictable, but it can improve the odds of getting things right, or getting fewer things wrong.

The difference between the inside and the outside view is well on display in the different and in some cases strongly held views about what kind of recovery is now unfolding in the U.S. PIMCO’s Mohamed El-Erian is the most prominent advocate of the “new normal”, a term he coined to describe a recovery with real growth of 1-2%, persistently high unemployment, and much greater government involvement in the economy. He has recently warned of a big letdown from the “sugar high” we are now experiencing in the market and the economy as the effects of the abatement of the credit crisis and massive government stimuli, both fiscal and monetary, begin to wear off.

He may be the most prominent, but he is not alone. In fact, it looks like he is the leader of a not so silent majority. The current consensus growth rate for the U.S. economy in 2010 is 2.4%. This is way below “normal” for the first year of a recovery, yet even it is well above what most thought only 6 months ago. In April the IMF projected negative growth in world output of 1.3% this year, and only 1.9% growth in 2010. That included a projection of zero growth in 2010 for developed countries. Projections such as these follow the classic inside view pattern: they look at current conditions, current trends, anchor on the most recent data, and adjust from there. Since the economy bottomed in March, almost all time series forecasts of economic improvement have been adjusted higher as the year wore on. They are still well below “normal.”

A recent Bloomberg story noted how in the second quarter of 2009 almost 75% of companies in the S&P 500 beat consensus expectations, which were then revised upward. Now, the consensus is for profits growth in 2010 to be up about 25% from 2009. Yet economic growth is expected to be only 2.4%, a ratio of profits growth to GDP2 growth of about 11. The outside view would show that the ratio has historically been around 6x, indicating either profits expectations are way too high, or growth expectations way too low. The outside view would favor the latter, as both time series have been steadily revised higher, and the early indications are that third quarter earnings are also coming in better than expected. What does the outside view say about what we should expect? In an article in The Wall Street Journal (“From Bear to Bull,” Sept 19, 2009) Jim Grant quotes economist Michael Darda as follows: “The most important determinant of the strength of an economic recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period.” In the first year of the recovery from the bottom of the Depression, the economy expanded 17.3%. If one adjusts for the drop in output in this recession, the outside view would put 2010’s expected growth rate at around 8%. Is the ‘new normal’ wrong? No one knows, yet. The core of the argument in its favor is an inside view: the consumer is over-leveraged, savings rates have risen from negative to positive and may stay elevated or go higher, balance sheets have been shocked by home price declines and the stock market collapse and need to be rebuilt. A mountain of corporate debt has to be refinanced, banks are not disposed to lend and capital requirements are going higher, and corporations will be cautious about hiring or expanding due to pervasive uncertainty.

A variant of the argument has it that with consumption elevated at 70% of GDP and the consumer retrenching, growth must be sluggish, profits will disappoint, and it will be hard for the stock market to make any headway. The outside view helps here too. In 1933, consumption as per cent of GDP was even higher than today, at 83%, and the savings rate was negative. The consumer deleveraged aggressively, pushing consumption as a percent to 73%, while the savings rate rose. Yet unemployment fell sharply, output grew rapidly, and the stock market went up over 100% from 1933-1937. There have been 8 times the consumer has deleveraged, and the market rose in 6 of those periods, with an average gain of 39%. Since the bottom in March, the S&P 500 is up over 60%, and year to date returns exceed 20%, yet skepticism (if not downright pessimism) remains high. This judgment is not based on sentiment readings, or surveys. As market veteran John Mendelson often points out, it is not what people say that matters, it is what they do. And what they are doing is buying bonds and selling stocks.

Through the first 9 months of this year, domestic equity funds had net outflows of $8 billion. During the first week of October, another $5 billion was redeemed. Bond funds, in contrast, had inflows of nearly $300 billion in the first 9 months of this year. Of the top 10 selling funds in America this year, 9 are bond funds and only one is a stock fund, and that one is the Vanguard 500 index fund. Stocks are pretty unpopular, despite having had a decent year so far, and why not? “Riskless” Treasuries have trounced stocks over this decade, having risen 85%, while if you’d bought the S&P 500 at the end of 1999 and held it through Sept 30 of this year, you’d have lost 14% over the same period. No profits at all for a 10-year period of investing in the biggest US stocks! Buy and hold is dead is a common refrain. Who wants to own a risky asset that does not go up, and one denominated in a currency that will surely go down? (We “know” the dollar will go down because it is on the front pages of the financial papers and magazines that it will do so. Everyone knows that—the only question is how far and how fast and will it collapse?)

That is the inside view, anyway. The outside view provides a different perspective. According to data compiled by Jeremy Siegel at the University of Pennsylvania, stocks have provided average annual real returns (after inflation) of 6.66% for all 10-year periods going back to 1871. (It is a curious coincidence that stocks bottomed on March 6, at 666 on the S&P 500). There have been 14 10-year periods where stock returns have been negative, including this one. In every one of the previous 13, the subsequent 10-year returns have exceeded 10% real, about 50% more than average, and more than double the return of government bonds. So every time stocks have performed poorly for 10 years, they have performed better than average for the next 10 years, and they have beaten bonds every time by an average of 2 to 1, yet investors can’t put money fast enough into bond funds, and continue to redeem equity funds.

As we sit at our desks pondering the myriad questions we’re faced with as investors, questions of great complexity, and ones of undeniable importance to our future well-being, it probably makes sense to get up and go outside, where the view is likely to be different, and clearer, and better.

Source: “Think Twice,“ by Michael J. Mauboussin, Copyright 2009, Michael J. Mauboussin;

Bloomberg; and “From Bear to Bull,” by James Grant, The Wall Street Journal, September 19, 2009.

To Rise, Inflation Faces an Uphill Climb

Inflation numbers might soon start to look scarier, but any inflation flare-up should be short-lived, and might even sow the seeds of its own demise.

The Bureau of Labor Statistics releases its producer- and consumer-price indexes for October. October PPI, due Tuesday morning, is expected to edge higher from September on rising food and energy prices.

Economists estimate consumer prices, due on Wednesday morning, also rose from September. "Core" CPI, which strips out food and energy prices, was up 1.5% last month from a year earlier, according to economists' forecasts, well below the 2% the Federal Reserve generally considers a tolerable inflation rate.

Those figures won't set off inflation alarms. But coming numbers could mark the start of more-notable upward pressure on year-over-year inflation growth, warns David Ader, head of government-bond strategy at CRT Capital. The reason: For the next few months, inflation will be measured against the worst depths of the recession, when prices fell across the board.

The numbers could be fodder for those on hyperinflation watch, particularly with commodity prices rising and the dollar fragile. But this "baseline effect" will only be temporary and won't faze the Fed.

Prices have clearly rebounded, but consumers haven't borne the brunt of those higher prices as much as producers have. Producer inflation has outpaced consumer inflation consistently since February 2008.

Companies have responded to their higher costs, along with generally weaker demand, by slashing their payrolls in the greatest numbers since the Great Depression.

A weak labor market can keep inflation in check, even if commodity prices rise. Petroleum-related costs account for just 2.3% of U.S. production costs, according to an analysis by Capital Economics. Employee compensation, on the other hand, accounts for 30.3% of production costs.

In fact, if rising commodity prices lead to more corporate cost cutting, then that will put more downward pressure on inflation.

To the extent that already-cash-strapped consumers, facing 10% unemployment, cut back on other items to pay for higher food and energy prices, that will also hurt demand, and prices, for everything else.

In other words, don't look for today's inflation pressures to last.

Thursday, November 19, 2009

Leading Economic Indicators Losing Strength

The AP details the "best in 25+ year" run of the leading economic indicators that still somehow managed to disappoint:

A private forecast of economic activity over the next six months edged up less than expected in October, signaling slow, bumpy growth next year.

The Conference Board said Thursday that its index of leading economic indicators rose 0.3 percent last month. Economists polled by Thomson Reuters had expected an 0.5 percent gain.

The index climbed 1 percent in September.

"We're still getting some positive momentum, but it looks like things are slowing down again," said Jennifer Lee, economist at BMO Capital Markets. "A lot of the economic growth has largely been driven by the government stimulus packages."

The government's Cash for Clunkers program boosted the auto sector and consumer spending, while tax credits for homebuyers have propped up the housing market.

Still, the indicators have risen for seven straight months. The Conference Board said last month that the 5.7 growth rate in the six months through September was the strongest since 1983. That ticked down to 5 percent growth in the six months through October.

Another disappointment is the performance of the indicators less the HUGE contribution of the interest rate spread (i.e. the steepness of the yield curve), which actually printed a negative number in October.

Why exclude interest rate spread? While the spread still relays the current monetary policy (i.e. when the yield curve is steep, the Fed is typically adding liquidity to the system which drives growth), this becomes less relevant when individuals and business aren't utilizing that liquidity (i.e. borrowing) to invest in "actual" economic activity. Instead we see that the liquidity is just being used to drive up prices of already rich, but not yielding 0% assets and/or to recapitalize a beaten down, but not yet out banking system.

Source: Conference Board

The GOD (glut of distillate) delusion

Could the world finally be catching on to the distillate glut problem? (Despite the Daily Mail getting completely the wrong end of the stick on the story).

We note even the normally media-shy physical trader Trafigura warned about the matter via Reuters on Thursday:
SINGAPORE (Reuters) - European oil trader Trafigura Beheer BV said on Thursday the worst of the credit crisis was over, but cautioned that the oil market was still grappling with severe oversupply and current prices were too high.

“As far as we can see, liquidity is back, and there’s a lot of appetite from existing banks and new banks. As they reposition their portfolios, commodities continue to feature quite highly on their agenda,” Trafigura’s Chief Financial Officer Pierre Lorinet told Reuters in an interview.

But he warned that given the ballooning stockpiles of oil products stored on ships, the current crude price of $80 a barrel was not justified.  “The level today seems too high compared to the pure fundamentals. But it goes back to how oil is trading today, and oil is trading like a financial asset.”  The severe oversupply would keep the market’s contango structure in place “for a while,” he added.

That, of course, follows near-term downside warnings from the likes of Goldman Sachs, Stephen Schork and BNP Paribas already.

But, we feel it’s Olivier Jakob at Petromatrix who really expressed the matter best on Friday. As he wrote (emphasis FT Alphaville’s):

As per our Tuesday ad hoc note on floating stocks; on a crude equivalent basis all of the OPEC and half of the IEA estimated oil demand growth for 2010 is already parked at anchor in floating stocks and these idled cargoes filled with oil are getting more and more attention.

By the end of the winter there is likely to be as much distillates afloat as in the total US at the end of winter 2007 and we expect that it will be more and more difficult for some of the Wall Street commodity banks to avoid mentioning the subject and to continue to hide the floating storage fill-up as “demand from emerging economies”.

The ICE Gasoil contango is currently widening and this will not work towards the reduction of these floating stocks. In an environment of spare refining capacity the only solver to the growing floating stocks of Distillates is a sharp reduction in OPEC supplies [ahem…Daily Mail], but only lower prices would trigger that.

The only answer that we see to GOD (Glut of Distillate) is a flat price correction sharp enough to force more OPEC supply cuts. Starting 2010 with WTI at 80+$/bbl and a contango in a low demand environment there will not be much returns to be expected from commodities by some of the largest financial institutions; hence with the evidence of the GOD being harder and harder to hide we would not be surprised if in a few weeks some of the Wall Street commodity banks start to change their tune and start to publicize the GOD. A flat price correction would anyway be needed in the first quarter to allow a repositioning from the large financial players at better entry levels.

Which, of course, doesn’t mean banks have been hoarding oil in a bid to drive the prices up. It means, if anything, they’ve been too slow to acknowledge the extent of the oversupply in the market and degree of muted demand, as well as depended too much on the idea that economic recovery will help spur demand by the year’s end.
Meanwhile, as Jakob states, the solution to the glut lies in Opec shut-ins — not more output .

Gladwell for Dummies

By Maureen Tkacik

This article appeared in the November 23, 2009 edition of The Nation.

November 4, 2009

That success is in the eye of the unsuccessful would seem to be the great unspoken dilemma dogging critics asked to consider the work of the rich and famous author and inspirational speaker Malcolm Gladwell. No matter how well intentioned or intellectually honest their attempts to assess his ideas, the subtext of Gladwell's perceived success, and its implications for their own aspirations in the competitive thought-generation business, obscures their judgment and sinks their morale. Nearly a decade has passed since the New York Times dryly summarized Gladwell's first book, The Tipping Point: How Little Things Can Make a Big Difference (2000), as "a study of social epidemics, otherwise known as fads," and yet, each Sunday, it still taunts perusers of the paperback nonfiction rankings, where it currently sits in sixth place. Gladwell may be merely "a slickster trickster" who "markets marketing" (as James Wolcott put it), or a "clever idea packager" who "cannot conceal the fatuousness of his core conclusions" (science writer John Horgan); he might even be an "idiot" (Leon Wieseltier). But one thing is clear: Gladwell is no fad. He is a brand, a guru, a fixture at New York publishing parties and in the spiels of literary agents hoping to steer writers toward concepts that will strike publishers as "Gladwellian."

A gaggle of irate critics, seeking to right this injustice, came charging, pens bravely brandished, only to watch themselves sink into the quicksand of Gladwell's infuriatingly memorable--"sticky," in Gladwellese--concepts and jargon. "Why does spending a weekend with Mr. Gladwell's best-selling books...lead to unhappiness and a pathological fixation on writing in rhetorical questions?" wailed Tom Scocca in the New York Observer. So discombobulated was Scocca by this critical game of pin-the-tail that when he finally stopped spinning, he stuck his sticker straight into a tautology. His solution to the Gladwell question was to posit that Gladwell's style had simply gotten too Gladwellian. "The problem with the Malcolm Gladwell Piece," as he put it, "is that it always seems to contain phrases like 'the problem with the Malcolm Gladwell Piece.'"

That Gladwell's most recent blockbuster monograph, Outliers: The Story of Success, actually purported to be about success only accelerated the vicious cycle of maddening self-reference, begging as it did a critical Gladwellian case study of Gladwell's own "success." The book's premise can be distilled to a single sentence: success is the result of many variables, most of which lie outside the control of a particular individual. Gladwell illustrates this point through various anecdotes and case studies that teach us a great many things we already know. For instance, hard work and education are important. Also: Culture Matters. Know Thyself. Practice Makes Perfect. Or, in the words of the Observer's Alexandra Jacobs, Outliers is about "how super-achievers like--well, like Malcolm Gladwell!--get where they are." And sure enough, in The New York Times Book Review, David Leonhardt took the bait, writing a brief alternative history of Gladwell's life crediting said "success" to his parents' professions. His mother, a psychotherapist, and his father, a mathematician, "pointed young Malcolm toward the behavioral sciences, whose popularity would explode in the 1990s," wrote Leonhardt; in addition, his mother, who "just happened to be a writer on the side," taught him "'that there is beauty in saying something clearly and simply.'"

But in examining Gladwell's success concurrently with his prescriptions for achievement, even his harshest reviewers damned themselves with faint criticism. When Michiko Kakutani dismissed Outliers for employing the patented Gladwell "shake-and-bake" recipe "in such a clumsy manner that it italicizes the weaknesses of his methodology," she still granted him a coherent method; when The Economist embraced the book's "engaging" and "intriguing" case studies while wryly enclosing the overarching "big idea" in quotation marks, it overlooked Gladwell's refusal to engage meaningfully with the world of ideas at all.

The Economist was astute to observe that the sheer obviousness of Outliers' core ideas, which were "unlikely to take even the least reflective reader by surprise," marked a departure from The Tipping Point. But when the magazine described The Tipping Point's chief attraction as its title concept's capacity to lend "the power of apparent inevitability to almost any argument," it failed to mention that the concept was central to Outliers as well--this despite that the purported aim of Outliers was to remind readers that "success," for most of us, is anything but inevitable. Such are the contradictions that seem to riddle not just Gladwell's thinking but the thinking on Gladwell's thinking, and perhaps even the thinking on thinking on that, and it is precisely these slippery but substantive contradictions that have allowed Gladwell to tout his revolutionary "big ideas" without couching them in anything so mundane as a logical, well-supported or otherwise sound argument. In this failing, he is not unique among either media mavens or the intelligentsia, but he is, perhaps, outstanding. "I don't really think of myself as an outlier," Gladwell told New York magazine late last year. "At the end of the day, I'm just a journalist."

In 1996 The New Yorker hired Gladwell as a staff writer after first publishing an essay he wrote for the magazine's "Black in America" special issue. He had spent the previous nine years at the Washington Post, where he covered health policy and science. In his rumination on the nuances of prejudice (which is the basis of the last chapter of Outliers), Gladwell defenestrated the fallacy that Canadians are less racist than Americans with an anecdote describing a coffee date with an old college acquaintance. The man launched into a tirade about the threat Toronto was facing from Jamaican immigrants, Jamaica being the outpost where all the most "troublesome and obstreperous" slaves had been sent. "I have told that story many times since, usually as a joke, because it was funny in an appalling way," wrote the half-Jamaican Gladwell. "I tell the story that way because otherwise it is too painful."

"Somebody," he concludes, "always has to be the nigger."

That Gladwell would rarely again end a story with such a downer of a line is in evidence in his new book, What the Dog Saw, a collection of his articles from his tenure at The New Yorker. The collection provides an archive of just a fraction of the stories he's written since the mid-'90s, when, under the employ of the magazine's famously buzz-obsessed former editor Tina Brown, Gladwell began studiously scrubbing his sentences of the mildew of the old, liberating his readers from references to anything that might dirty undiluted all-newness with the dourness of precedent. Gladwell focused his sights on the more vacuous anxieties of the heirs and heiresses of American affluence. In 1999 he wrote a story called "Running From Ritalin," about the wildly overprescribed drug for attention-deficit disorder, which he claimed was merely the modern answer to a widespread dopamine deficiency that previous generations had treated with cigarettes and cocaine, "a drug," he explains helpfully, "that people thought would help them master the complexity and the competitive pressures of the world around them." Soon after, Gladwell would tackle college admissions, shopping, parenting, standardized testing, corporate culture and transformative household inventions of the twentieth century, often all in the space of a few dozen column inches, and in the template that he had fashioned in the Ritalin story: a cheerful, conversational voice deployed in a perfectly paced dopamine prose that had the palliative effect of nullifying whatever concerns readers might have about this product or that problem.

Gladwell promised readers mastery of the complex and competitive world around them, if only they would accept the facile conclusions he extrapolated from the findings of the many endearingly eccentric, iconoclastic scholars and researchers who were busy applying the scientific method to the investigation of everyday living. These scientists tended to share a universal message: contrary to our latent anxieties about modern life, everything is all right--or can be, with a few minor psychopharmacological tweaks--so come on, get happy! From a stammering "retail anthropologist" we learn that shoppers are not nearly so slavish and easily manipulated as the chain stores believe them to be. From a "heroically counterintuitive" historian of loopholes we learn to appreciate, rather than resent, tax cheats, smut peddlers and sources close to the investigation who exploit the letter of the law to undermine its spirit. From a series of surprisingly sincere marketing executives we gain a nuanced appreciation for both the fullness ("amplitude," in industry parlance) of the taste of ketchup and the subtle subversiveness of early Clairol commercials. "In writing the history of women in the postwar era," Gladwell wonders in this last piece, "did we forget something important? Did we leave out the hair?"

Gladwell's protagonists are generally intelligent but ordinary folks who have imbued their work with a passionate practicality. Their laboratories are courtrooms and high-concept shopping malls, office parks and African villages, but whatever their locale, they are always buried in data, endless stacks and reams and massive videotape libraries full of tens of thousands of hours of footage documenting their findings, their desks buckling under thick piles of "carefully annotated tracking sheets." With this abundance of evidence they espouse theories that Gladwell depicts either as regrettably naïve or courageously counterintuitive, depending on whether he is debunking conventional wisdom or advancing a hitherto unknown experimental truth. He takes pains to skewer, for instance, the delusion that the Central Park jogger was saved by a "miracle" and the misconception that the Challenger explosion revealed a hideously corrupt species of neglect at NASA. Particularly vexing to Gladwell and his data marshals are overblown health hazards scaring the consumptive populace off such marvels as breast implants, estrogen therapy, newfangled birth control pills and products containing the fat substitute Olestra, the famed and feared "stool loosening" side effect of which Gladwell expends many sentences likening to that of bran cereal.

A recurring straw man for Gladwell is misguided evangelism, generally the kind that rallies around fringe causes, though his aversion to strident moralism usually keeps him from fixing on a villain. A notable exception is the late diet guru Dr. Atkins, upon whom he loosed his most withering scorn in a comprehensive takedown of the diet industry published in 1998. Otherwise Gladwell seems to regard his intellectual foes as somewhat pathetic figures. He wants to love, for instance, Dr. Susan Love--the charismatic but suspiciously shrill critic of estrogen therapy he profiled in 1997--but the data just don't support her claim that the treatment dramatically increases women's risk of developing breast cancer. Estrogen, however, does cause breast cancer, we learn three years later in "John Rock's Error," the cautionary tale of another wayward evangelist, the Roman Catholic doctor who helped develop the birth control pill. Rock lobbied the Catholic Church to lift its ban on the pill and, having failed, eventually lost his faith in God and drank himself to death.

In a 1998 article called "Do Parents Matter?" Gladwell championed the findings of one Judith Rich Harris, a "fragile, elfin" and grandmotherly editor of child-psychology textbooks who had published a groundbreaking study purporting to show that parents are rarely to blame for screwing up their kids. Harris had formulated her hypothesis while editing a book on juvenile delinquency that offhandedly credited the motivation for such behavior to the desire to be more like adults. "Adolescents aren't trying to be like adults--they are trying to contrast themselves with adults," she explained to Gladwell. But like a fickle teenager, Gladwell would casually shrug off the wisdom he had gleaned from Harris in a piece that appeared several months later. Here he contrasts the television show Beverly Hills, 90210, which "played to the universal desire of adolescents to be grownups," with its spinoff, Melrose Place:

"Melrose" was the opposite. It started with a group of adults--doctors, advertising executives, fashion designers--and dared to have them behave as foolishly and as naively as adolescents. Most of them lived in the same apartment building, where they fought and drank and wore really tight outfits and slept together in every conceivable permutation. They were all dumb, and the higher they rose in the outside world the dumber they got when they came home to Melrose Place.
 In the mid-nineteen-nineties, when a generation of Americans reached adulthood and suddenly realized that they didn't want to be there, the inverted world of Melrose was a wonderfully soothing place. Here, after all, was a show that ostensibly depicted sophisticated grownup society, and every viewer was smarter than the people on the screen.

But for all this vapidity, Gladwell finds something to admire in the melodrama: restraint.

The wonderful thing about "Melrose Place" was that just when you thought that the show was about to make some self-consciously postmodern commentary on, say, the relationship between art and life, it had the courage to take the easy way out and go for the laugh.

The publication of Gladwell's first book, The Tipping Point, proved his courage to be of a similar character. The Tipping Point was named for an epidemiological phenomenon that he had introduced to the public when he covered healthcare policy for the Post. Healthcare reporting is a beat that notoriously leaves journalists disillusioned by the destructive influence of money and markets on the public welfare; in Gladwell's case, it provided the central metaphor for a book that applied the observations of health officials to the business of "want creation," otherwise known as branding. Gladwell describes the genesis of the book in detail in a "Q&A With Malcolm" on Gladwell.com:

The word "Tipping Point"...comes from the world of epidemiology. It's the name given to that moment in an epidemic when a virus reaches critical mass. It's the boiling point. It's the moment on the graph when the line starts to shoot straight upwards. AIDS tipped in 1982, when it went from a rare disease affecting a few gay men to a worldwide epidemic. Crime in New York City tipped in the mid 1990's, when the murder rate suddenly plummeted. When I heard that phrase for the first time I remember thinking--wow. What if everything has a Tipping Point? Wouldn't it be cool to try and look for Tipping Points in business, or in social policy, or in advertising or in any number of other nonmedical areas?

The product of this endeavor was what Gladwell calls "an intellectual adventure story," a genre-crossing book that whipped up a "little bit of sociology, a little of psychology and a little bit of history," tossed in some epidemiology and "examples from the worlds of business and education and fashion and media," and hocked the resulting mishmash of soft social science and hard cases to help readers make "sense of the world, because I'm not sure that the world always makes as much sense to us as we would hope."

The temptation to try to calculate The Tipping Point's own tipping point seems thus far to have been resisted, but there is no doubt that the book reached a great many Mavens, Salesmen and Connectors and eventually became a phenomenal success. To what was that success attributable? Surely encoding the principles of bestsellingness and infection by word of mouth in the book's DNA did some of the work, but there were other contributing factors, not the least of which was what has become Gladwell's signature style, which projects the expertise of a scientist and the easy helpfulness of the guy who delivers the local television station's "news you can use" segment at 6:25.

In searching for an anecdote or image with which to convey the ultra-absorbency of Gladwell's book as compared with that of his soggier-sentenced peers, I found myself remembering a story Gladwell wrote in 2001 about the technology of diapers. In this story, Gladwell reported that "those in the trade" refer to the waste that diapers are engineered to retain as "the insult," and this image seems to me as useful as any for thinking about Gladwell's success. His masterful maneuver was to engineer a style that artfully conceals "the insult," honing it in his articles before finally unleashing it in book form with The Tipping Point.

What made The Tipping Point remarkable was not the diagrams or axioms or anything it includes but rather what it left out: that is, any discussion of the real risks of business at a moment when its sexiest sector, technology, was increasingly uncertain about how it was going to survive once it had burned through its remaining seed money. Instead, Gladwell celebrated the way certain personality types can, given a hospitable set of circumstances, or "context," conspire with extraneous forces to profoundly alter human behavior--without ever dwelling on how this might be a bad thing or bothering to provide a clear definition of the word "context." In the "Q&A," Gladwell says he hopes readers will use the "new set of tools"--"brain software"--he provides them to create "'positive' epidemics" of their own. Dr. Atkins is nowhere to be found, nor is Susan Love; instead, he populates his book with a nonthreatening cast of folksy, relatable characters--behavioral psychologists, petty criminals and criminologists, effusive socialites and seminarians, Big Bird and Peter Jennings--and tells their stories in a manner so adamantly engaging that it reads suspiciously as if it had been focus-grouped. In conversation with Tom Scocca, Gladwell characterized his style as one that screams "Please, please, don't leave me," and indeed his stories often seem designed to do nothing more than to keep people reading.

This is nowhere more apparent than in What the Dog Saw. The book is mostly old news, with the exception of a preface in which Gladwell attempts to justify the methodology behind his pieces, an explanation, it appears, that is also meant as a rejoinder to all those aforementioned heckling critics who have failed, fundamentally, to comprehend Gladwell's project. Complaining that his greatest frustration as a writer has been the angry reader who believes that Gladwell wants him to "buy" his argument, Gladwell asserts,

Good writing does not succeed or fail on the strength of its ability to persuade. Not the kind of writing that you'll find in this book, anyway. It succeeds or fails on the strength of its ability to engage you, to make you think, to give you a glimpse into someone else's head--even if in the end you conclude that someone else's head is not a place you'd really like to be.

One could quibble with the assertion that a writer's obligation to persuade begins and ends with keeping the reader reading, not in order to convince him of certain conclusions but merely to enable him to satisfy that basic human impulse to explore and temporarily inhabit other minds. But the critic's natural persuasion is to attempt to inhabit the mind of a writer, to evaluate how satisfying the stay was, even in the probable case that one wouldn't want to be lodged there permanently. And one thing that frustrates this reader of Gladwell is his obvious aversion to giving us any privileged access to his mind, encouraging us instead to inhabit more fully the consciousnesses of dogs and their whisperers, when one would hope that his mind is an infinitely more interesting place to be. But as Gladwell tells us, "self-consciousness is the enemy of 'interestingness,'" and so perhaps it is that impulse to protect the self from criticism that has so hampered his work, which he chronically undersells even as his books outsell his every rival.

"A book, I was taught long ago in English class, is a living and breathing document that grows richer with each new reading. But I never quite believed that until I wrote The Tipping Point," he gushed in the afterword to the 2002 edition, citing the "conferences and retreats and sales meetings" where he had mingled with his readers. "In a world dominated by isolation and immunity, understanding these principles of word of mouth is more important than ever."

Gladwell has said that of all the people he has interviewed, he most identifies with Nassim Nicholas Taleb, the polymath former derivatives trader turned "risk management" guru whom he profiled in April 2002, after Taleb published his breakthrough bestseller Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets. Taleb, now "distinguished professor of risk engineering" at NYU, writes chatty, nonlinear nonfiction books that are invariably described as intellectually "provocative...in the tradition of" Malcolm Gladwell. Taleb's follow-up, The Black Swan: The Impact of the Highly Improbable (2007), examined a phenomenon of the same genus as Gladwell's outlier: a "black swan," according to Taleb, is an unlikely but "consequential event" with profound transformative implications.

But if Taleb shares something in content and style with Gladwell, his books have a markedly different tone. Taleb considers himself a connoisseur of the "epistemic arrogance of the human race," and, unlike Gladwell, he rather conspicuously relishes the chance to hurl "the insult"--in all its freshness--at those aspiring bigwigs misguidedly combing his books for investment strategies. In Fooled by Randomness, he mocks his own youthful distrust of philosophy, which he considered "an activity reserved for those who were not well versed in quantitative methods and other productive things," and then describes turning to it later in life, after realizing he was "generally repelled by the wealthy, generally because of the attitude of epic heroism that usually accompanies rapid enrichment." He recounts his gradual recognition that

$10 million earned through Russian roulette does not have the same value as $10 million earned through the diligent and artful practice of dentistry. They are the same, can buy the same goods, except that one's dependence on randomness is greater than the other's.... Deep down, I cannot help but consider them as qualitatively different.

In The Black Swan, Taleb elaborated on what Gladwell has called Taleb's "heretical" idea. Cataloging industries on a spectrum between two poles, Extremistan and Mediocristan, where finance in the era of securitization and the art world in the age of digital reproduction hovered near Extremistan and dentists, mechanics and community organizers were still largely anchored in Mediocristan, Taleb closed in on a flaw in the logic of modern capitalism that he felt to be gravely dangerous. The world's financial and consumer superpower had shifted its economy radically toward the "scalable" activities of Extremistan--where the same number of labor hours could result in one sale or 1 million--while maintaining Mediocristan's solidly "average" talent base as well as the base's conventional sense that "success" is largely a function of craftsmanship, experience and innate talent. He did not blame books like The Tipping Point for encouraging readers to believe they could game their fates in the face of Extremistan's governing randomness, but he could have.

Gladwell's profile explained none of Taleb's ideas in detail, but its timing was impeccable: in 2002 Wall Street was reeling from the "blow-up" of Enron, the Twin Towers and the accounting industry, and Taleb, who claimed his methods had insulated his fund from such a fate, cut a compelling figure. "We cannot blow up, we can only bleed to death," Taleb told Gladwell. Gladwell likened Fooled by Randomness to Martin Luther's ninety-five theses, solemnly concluding:

This kind of caution does not seem heroic, of course. It seems like the joyless prudence of the accountant and the Sunday-school teacher.... We associate the willingness to risk great failure--and the ability to climb back from catastrophe--with courage. But in this we are wrong. That is the lesson of Nassim Taleb...and also the lesson of our volatile times.

Mirthless as he may appear to Gladwell, Taleb is a millionaire who gets to say he told you so. Why has no one said the same for Gladwell? After all, it's true. Perhaps the reason is partly the unyielding chicken-egg binariness of his patented "To intuit, or to counter-intuit?" method, which proved insufficient to explain the increasingly complex topics he approached after Taleb, most notably the implosion of Enron. In "The Talent Myth," published in July 2002, he declared the firm a casualty of the article's titular fallacy, which was then in vogue among many elite companies. He used as evidence the career of Lou Pai, who found himself kicked upstairs so many times that when he left Enron in 2001, he was CEO of one of its largest subsidiaries: "Because Pai had 'talent,' he was given new opportunities, and when he failed at those new opportunities he was given still more opportunities...because he had 'talent.'"

This certainly was likely to interest anyone who bought Taleb's contention, in Fooled by Randomness, that the most vexing problem of modern finance was its practitioners' tendency to conflate success and talent. According to their logic, failure equals talent, too! But if both were true, surely an industry rife with Lou Pais was not a little corrupt?

Alas, when presented with the chance to implicate any self-aggrandizing Extremistanis in the crime of succumbing to their context, Gladwell never missed an opportunity to miss an opportunity. The lesson of Enron, he wrote in "The Talent Myth," was that smart people might be overrated. Five years later, in "Open Secrets," he offered another view, challenging readers to compare Enron with Watergate. Whereas Watergate had been a puzzle, a scandal with an obvious narrator and cast of perpetrators, Enron was a mystery--a scandal too complex to comprehend. "Enron's downfall has been documented so extensively that it is easy to overlook how peculiar it was," he wrote. This assertion might ring less false were it followed by an elaboration of how it differed from other "mysteries": the Enron crooks were caught and prosecuted. One noteworthy event Gladwell fails to mention is the panicked plea of Enron CEO Ken Lay for a federal bailout on grounds of the "systemic risk" the firm's collapse would pose, a plea rejected by Treasury Secretary Paul O'Neill. All of this appears to muddy Gladwell's earlier assertion that Enron and its management consultants at McKinsey

believe in stars, because they don't believe in systems. In a way, that's understandable, because our lives are so obviously enriched by individual brilliance. Groups don't write great novels, and a committee didn't come up with the theory of relativity.

But stars do believe in systems--at least when the system is down several trillion dollars.

Now let's skip ahead to "Group Think," an article Gladwell published in December 2002, just a few months after "The Talent Myth," by which time Gladwell had fixed his lens on some new constellations, the stars of the television show Saturday Night Live:

We are inclined to think that genuine innovators are loners, that they do not need the social reinforcement the rest of us crave. But that's not how it works, whether it's television comedy or, for that matter, the more exalted realms of art and politics and ideas. In his book "The Sociology of Philosophies," Randall Collins finds in all of known history only three major thinkers who appeared on the scene by themselves: the first-century Taoist metaphysician Wang Ch'ung, the fourteenth-century Zen mystic Bassui Tokusho, and the fourteenth-century Arabic philosopher Ibn Khaldun. Everyone else who mattered was part of a movement, a school, a band of followers and disciples and mentors and rivals and friends who saw each other all the time and had long arguments over coffee and slept with one another's spouses.

Stars! They're just like us. Which is to say, every time Gladwell begins to close in on a conclusion of real meaning or intellectual impact, he clicks his heels and returns to the mental Melrose Place of quippy clichés. What's more, he apparently has no problem espousing the whole-truthness of two antithetical clichés--the innateness of genius and "The Power of Context" (as Gladwell had christened this truism in The Tipping Point) at almost simultaneous moments in time. Reduced further, depending on Gladwell's narrative needs, genius is either nature or nurture, and he has cheerily eaten his cake, wrapped it up neatly in a take-away box and left us wondering where the crumbs disappeared to.

It may seem obvious to some that these are false dichotomies; neither half is ever true to the exclusion of the other. But that is the rub: there are a great many book buyers determined to hedge their bets in precisely this Gladwellian mode. Depending on the situation, they want to believe in the sovereign power of either nature or nurture--to convince themselves that anyone can be a success but also that should one be so unfortunate as to fail, that failure was predestined by an accident of fate. This is the contradictory "story of success" that runs through Gladwell's articles, The Tipping Point and Outliers. The "power of apparent inevitability," as The Economist termed it, is a narrative that his hungriest readers can use to explain any turn their lives might take, and it was precisely these readers who flooded Gladwell's e-mail inbox with raves about how The Tipping Point had empowered them to take control of their lives and "contexts."

By the time Gladwell produced a sequel to The Tipping Point, Blink, his preference for light vignettes featuring plucky heroes over grimmer fare was proving its own insult. In Blink's afterword, he describes the book as "a journey into the wonders of our unconscious" but one that should not "be confused with the unconscious described by Sigmund Freud, which was a dark and murky place filled with desires and memories and fantasies that were too disturbing for us to think about consciously." Instead, Blink plumbs an unconscious realm that is surprisingly hospitable. Gladwell makes the case that because human existence is entirely too rich and nuanced to be reducible to data or logic (and by extension, to arguments or allegations), reason and reflex blend over time to yield snap decisions that are often better than the best-laid plans.

If nothing else, it was a counterintuitive moment for Gladwell to come out in favor of intuition: by 2005 the citizenry was turning against the warmongering gut instincts of the commander in chief. In Iraq, the number of casualties continued to mount daily despite Defense Secretary Donald Rumsfeld's entreaty for the public to sit back and wait for the war to reach its tipping point. Blink does include a chapter on the war, in which Gladwell reveals that Rumsfeld's disastrous battle plan had been roundly defeated by a retired Marine general named Paul Van Riper in an elaborate simulation game in 2002 (the Pentagon then ran another test, in which it sabotaged Van Riper by installing a disloyal deputy and disarming the bulk of his equipment). But despite his proximity to these proceedings, Rumsfeld is never mentioned by name in Blink. Nor, for that matter, is Bush.

It seems odd that Gladwell would write an entire chapter about the war without ever mentioning two of its main protagonists, almost as if he might believe his readers were paying so little attention that they could forget whose hunches about a failed battle plan had gotten them into this mess. And perhaps he did. In The New Republic, Richard Posner jeered that Blink "is written like a book intended for people who do not read books." But that's not quite right: Blink appears to have been written not for people who don't read books but for people who read only books that spend years on the bestseller lists, books you can talk about with your boss or buy in bulk for the marketing department.

Gladwell has documented his love-hate relationship with such books: he has gone on the record about his disdain for the diet-book industry, but he has also described his admiration for Rick Warren's The Purpose-Driven Life. And if Taleb is Gladwell's hero, his villain is, as Taleb's was, the mendacious and self-aggrandizing CEO. In 2001 Gladwell ridiculed Michael Eisner, Sumner Redstone and Jack Welch for ripping off Lee Iacocca's formula for the corporate memoir wherein modest, homespun beginnings and "gruff, no-nonsense" mentors lay the foundations for a self-made man to make his way to the corner office. Outliers is Gladwell's corrective to this genre. In it, we learn that Bill Gates, Steve Jobs and sundry other titans of Silicon Valley were all born into affluent households in the mid-1950s and otherwise benefited from a variety of cultural and circumstantial factors that yielded some of the world's most successful people.

And so once again we find Gladwell muckraking in the trenches of banal cliché and thereby reinforcing said cliché--and, more insidiously, banality itself. In Outliers, as in Blink, he appears to assume that the unexamined life is the only sort his readers could be living, though lessons with titles like "Demographic Luck" and "The Importance of Being Jewish" suggest that he may have downgraded his expectation of who his readers are from the less savvy to the truly oblivious. Outliers contains a few new terms and morsels of trivia: the 10,000-Hour Rule describes the number of practice hours one must put in to attain true genius; we also learn that fourteen of the seventy-five individuals on Gladwell's list of the "richest people in human history" were Americans born between 1831 and 1840. (Cleopatra is No. 21.) But for the most part, the book's first section, "Opportunity," contains nothing that will enlighten anyone who has given even a small fraction of 10,000 hours of thought to the word's meaning.

But it is when Gladwell ventures from the home of the brave to foreign cultures--primarily the Asian ones we've voted most likely to succeed--that Outliers begins to rely on clichés that are not only inane but, in some cases, comically offensive. In a section on the crash of a Korean Air passenger jet, Gladwell blames cultural deference for enabling numerous preventable in-flight disasters on the carrier--and credits the airline's ability to overcome its rigid "cultural legacy" for steering Korean Air back toward safety. We also travel to China's rice paddies, where the Chinese long ago learned--at least in the south, the region where rice is farmed--teamwork, self-discipline and the appreciation of complex but "meaningful" work that has enabled them to dominate global manufacturing. And in the most convoluted section of Outliers, Gladwell repurposes an argument from a book called The Number Sense that posits that Asians are good at math because in Chinese, the numerals one through nine are single-syllable, so brief to think or speak that Chinese children can fit a great many of them in their heads in any given time span, which gives them a self-perpetuating cognitive edge from the age they learn to count. From here, Gladwell explains that these tiny numerals are ordered in a system simpler than ours (the number eleven, for example, is expressed as ten-one) and that this ease and logic, combined with the discipline they've learned diligently tending their rice paddies, is what makes not just Chinese students of mathematics but also Japanese and Korean students superior to their Western counterparts.

For now let's ignore Gladwell's agronomical observations as well as the fact that the Number Sense argument can't apply to Japanese or Korean, in which several of the numbers from one through nine are polysyllabic. Let's instead turn a Gladwellian eye to a sixteenth-century Italian missionary named Matteo Ricci. One of the first Westerners to travel to China, in 1583, Ricci found a nation that was not, it might surprise you to learn, very good at math. His twenty-seven-year stay in China is described in detail in The Memory Palace of Matteo Ricci (1984), a book by historian Jonathan Spence. Under previous dynasties the Chinese had made significant advances in mathematics, but during the European Renaissance China's Ming emperors--whose primary goal was to reassert Chinese cultural supremacy after a hundred years of humiliating Mongol rule--prioritized literature and art over scientific discovery, a bias they reinforced through a rigorous examination system that governed advancement in civil service. The turning or tipping point or whatever came when Ricci learned Chinese. While all the conventional, data-supported wisdom tells u