“You may ask yourself; how did I get here?” Much like the 1980 Song “Once in a Lifetime” suggests, you probably spend a fair amount of time each day trying to “predict” what’s to come. Indeed, how we got here and what will happen tomorrow is often the domain of those mistakenly thinking there is order to this thing we call life and more importantly for our purposes “Investing”. Many of you spend an inordinate amount of time trying to predict the unpredictable. You use all kinds of Ouija Board tactics and misguided biases to try to make sense of the randomness that is human existence. Often times a client or would-be client will explain to me that this is all so very predictable if we just look for the right indicators. If a portfolio manager has a good year and subsequently the short-sighted media gives that person undue attention in an effort to boost ratings and sell more stuff, many will flock to hear and or invest with said person.
Each year Morningstar the ubiquitous rater of all things investment gives Mutual Funds a Star Rating. These ratings range from one to five stars with five being in their not-so-humble opinion the best of the best. To quote our friends the “Talking Heads”, “You may tell yourself?”, “This is how I will pick my mutual funds going forward. I will simply wait for Morningstar to rate these funds and pick only the ones with five stars and I too….will have a Large Automobile and a Beautiful Wife” (it’s in the song don’t get too worked up). The problem with this strategy is that it employs two biases that in my opinion (not humble at all 😊) are an investor’s worst enemy, “Hindsight and Immediacy Bias”. You see Hindsight Bias is the belief that you somehow knew once presented with an outcome it (that outcome) seemed predictable and in fact, you more or less knew that outcome was likely despite zero evidence to support this thesis. An example of this would be the guy crowing at a party (easy on the free drinks sport) that he saw the “whole thing” coming. Whole thing? Yes, the whole thing. He saw the Financial Crisis of 08 despite there being no evidence he got out of real estate or went to cash just before all hell broke loose. He saw the market rebounding hard and fast from the March Covid lows despite the fact that he stayed in cash the entire rest of the year. You see the problem with using past events and more correctly recent events to gauge future events is that your instincts are more often than not, wrong. Sometimes a little wrong and frequently very wrong. You see our friends at Morningstar provide a very important service, they tell us what “did” happen which is useful. How a fund or investment reacts to high interest rates, a recession, Geopolitical Strife, and alike are useful, but largely ineffective in telling us what “will” happen. The problem is that statistically a Five Star Mutual Fund is more likely to become a One Star Mutual Fund than remain a Five Star Fund. In short, once again we are seeking patterns where none exist. As illustrated Hindsight Bias is the belief that you knew something you very likely did not. Recency Bias is the belief that whatever happened yesterday will likely persist (see Florida weather as a lesson in humility). Recency bias is looking at your statement and finding the three stocks that are down and deciding to sell them and add to the three that are the best performers giving zero respect to the cycles that have existed in securities and economies for centuries. Today’s Stinker is more likely to shine in the period ahead than today’s Rock Star. If we know anything it’s that things change. History may not repeat itself but as Mark Twain famously said “it often rhymes”. The rhyme is the randomness. What doesn’t change is your inability to predict the ebbs and flows of those cycles in advance of them. We invest because we believe in the fundamental soundness of our Capitalistic System not because we know how the system will react to any given stimulus or what the next stimulus will be. To that end, I have correctly predicted that our risk markets would bring long-term growth, generally better than those in “fixed” and “riskless” investments over my now 36-year career. The things I have failed to predict are both numerous and notorious. COVID, 9/11, The Housing Crisis, Russia invading Ukraine, Bernie Madoff, most presidential elections, the Impact of social media, Elon Musk, Google, Amazon, and of course the World Domination of Taylor Swift.
Folks at our humble little practice now have over 2 Billion in total assets we do our best to anticipate long-term cyclical shifts. We understand the math of Bond Durations and the correlation of loose Fed policy and Corporate Liquidity. We understand that bad things will happen, but know that our best defense is sound principles and a disciplined long-term outlook. “Red stocks” will likely not remain that way forever and “green stocks” (the ones you like so much) will eventually spend some time out of favor. Knowing that we don’t know exactly when is way more important than incorrectly thinking the opposite.
In the end, thoughtful planning and discipline will determine whether you live in a “beautiful house or a shotgun shack”, not seeing false patterns and giving in to untrustworthy biases.
“Let the Days go by, the water will still be flowing underground”.
Peace and Happy Thanksgiving,
Scott