In July this year, Australia’s consumer confidence fell into a 16-year low (see Economic gloom deepens). In today’s Alan Kohler’s financial news report on ABC 7pm News, he plotted a graph of petrol prices and consumer confidence survey readings. You could see that there was an inverse correlation between petrol price and consumer confidence. Alan Kohler said that this graph was to “show you” where the fall in consumer confidence came from.
For us, we are not so sure about that.
Here, we are not making any judgement on this implied assertion. But we would like to point out a potential mental pitfall: does correlation necessarily implies causality? That is, does the inverse correlation between petrol price and consumer confidence necessarily imply that the downward trend of the latter is caused by the upward trend of the former? Could the reason for the correlation be due to both having the same underlying cause?
This is one thing that investors must always be on the look out for. Using statistics, we can calculate the correlation factor between two time series. It is one thing to find out that both of them turn out to have a strong correlation (or inverse correlation) relationship with each other. It is another thing to interpret the meaning of this finding. As we quoted Wilhelm R?pk in Why is the market so easily tossed and turned by dribs and drabs of data?,
By the statistical method, we ascertain facts, but we cannot explain them, i.e., bring them into logical order so that we ?understand? them.
Beware of analysts, especially the ones who are quoted on the media, who are very loose with the interpretation!
