Recency Bias, as demonstrated by Lawrence O’Donnell

LincolnAmong the effects of recency bias is our tendency to overvalue and overemphasize the recent past as compared to more distant events and then to extrapolate it into the future. Lawrence O’Donnell was guilty of it to a remarkable extent this week during a discussion on his show relating to President Obama’s approach to radical Islam and a particular speech he had delivered that day that O’Donnell thought pandered to the religious (critics, of course, thought the President was trolling). Notice how he prefaced his criticism (my emphasis; you can watch this segment of O’Donnell’s show here).

President Obama, who is the most gifted writer and speaker in the history of the American presidency, today delivered the worst speech of his presidency.

Even allowing for the possibility that O’Donnell was using hyperbole to make his criticism seem more pointed, the claim that the current president — who undoubtedly is exceptionally gifted — “is the most gifted writer and speaker in the history of the American presidency” is, frankly, absurd. Continue reading

A New Kind of Investment Outlook

Outlook212015 Outlook2014-2015

Forecasting Follies

Nobody’s perfect.

That universal truth is easy to prove, of course, and no sane person would deny it. Indeed, even the smartest of us are far from immune even in our areas of expertise when we’re actively trying to do our best. A famous study by the U.S. Institute of Medicine concluded that up to 100,000 people die each year due to readily preventable medical errors. Since physicians are among the smartest and most highly trained professionals imaginable, being stupid is obviously not a prerequisite for making mistakes, even horrible mistakes.

It’s also easy to prove how error-prone we are in the investment world. Every year I take a look at various predictions for the year that’s ending and they are uniformly lousy in the aggregate. Moreover, when somebody does get one right or almost right, that performance quality is not repeated in subsequent years.

2014 provided more of the same in this regard. The median S&P 500 forecast among 50 top-end investment experts called for a year-end level of 1,950, up 6.44 percent on the year. As noted above, the actual closing level was 2,059, up 11.39 percent, essentially five full percentage points higher. That’s a miss of monumental proportions.

Last January, analysts called for far higher oil prices, firmer inflation, a worse jobless rate and higher interest rates. The exact opposite happened in each of those areas. The consensus crude oil price forecast was nearly $95 per barrel (up a bit) and 72 out of 72 economists were anticipating higher interest rates and lower bond prices. Advisor magazine reported that bond market sentiment was utterly bearish, leading pundits to recommend that investors limit their bond holdings to the shortest maturities in 2014. Meanwhile, 30-year U.S. Treasury bonds returned nearly 30 percent. Last April, Peter Schiff of EuroPacific Capital made the bold prediction that the “Federal Reserve’s quantitative-easing program will push gold to $5,000 an ounce.” The shiny yellow metal closed 2014 at just under $1,200, 80 percent or so lower than Schiff’s target.

Alleged experts miss on their forecasts and miss by a lot. Let’s stipulate that these alleged experts are highly educated, vastly experienced, and examine the vagaries of the markets pretty much all day, every day. But it remains a virtual certainty that they will be wrong often and often spectacularly wrong. On account of hindsight bias, we tend to see past events as having been predictable and perhaps inevitable. Accordingly, we think we can extrapolate from them into the future. But the sad fact is that we can’t buy past results. Continue reading

Signing Day and the Investment Process

davidYesterday – the first Wednesday in February and thus the so-called National Signing Day – was the first day that high school seniors could sign letters of intent to accept an athletic scholarship to play Division I college football in the fall. It’s the culmination of a long recruiting process and crucial to the success of teams and coaches. It can get more than a bit ridiculous.

Some players announced their intentions using live animal props, or worse. One recruit picked Texas over Washington based on a coin flip. At least it wasn’t for the gear, officially anyway. And Snoop Dogg will be giving up his support for USC to cross-town rival UCLA because his son picked the Bruins, where he’ll join P. Diddy’s kid on the team. Cornerback Iman Marshall, a big-time USC signee, has a self-styled “commitment video” that’s particularly absurd.

But the coaches and the media outlets that cover college football recruiting (of which there are an astonishingly high number) take it all very seriously indeed. As the parent of a DI player (at Cal, see above), *I* took it very seriously.

These various publications generally rate high school players being recruited via a “star system” of from two to five stars, with five stars being reserved for top 50 players, four stars for the next 250 (numbers 51-300), three stars for the next 500, and two stars for players who are considered “mid-major” and thus not good enough for the top conferences and teams. Alabama’s current recruiting class is usually reputed to be the nation’s best, for the fifth straight year, averaging out to 4.08 stars. And while it’s not much ado about nothing, it’s much ado about a lot less than you’d think, and in a different way than you probably think. Continue reading

What Advisors Think, Know and Can Prove

res0215coverMy February Research magazine column is now out online. It’s a good one. Please give it a read.

There’s a famous expression to the effect that it’s hard to reason someone out of a position that wasn’t reasoned into, and there’s truth in it. It’s hard enough to influence or help alter a person’s beliefs—about investing, religion, politics or even the Yankees’ relative evilness—much less someone’s life commitments. But if we’re to have a chance to make better, more reality-based decisions (about investing and everything else), we’re going to have to try and to begin with ourselves.

What Advisors Think, Know and Can Prove

Sheldon Cooper Illustrates Bias Blindness

“Don’t you think if I were wrong I’d know it?”

Further suggested reading:

Seven Things

7things7Brain Pickings is a fantastic site and a wonderful daily read. It has nothing (directly) to say about the markets and investing, but it has loads to say about life. I could not recommend it more highly. To celebrate the site’s seventh anniversary last Fall, proprietor Maria Popova wrote a lovely little piece describing the most important things she learned during that time. A short video has now been developed outlining these themes. It’s well worth a watch. I hope you will.

To a Happier New Year

"homeless - please help" signNot surprisingly, I have been thinking a lot about my annual Investment Outlook (due out in about a week) of late. It’s a great opportunity for me to look at the “big picture” overall and at the major themes that we should be following in the markets as 2015 opens. The overall picture seems very bright indeed. The U.S. economy has continued to improve, if not as quickly as we all would want. GDP has remained in the 2-2.5 percent range with some recent signs of quickening growth. Inflation has dipped below 1 percent, largely thanks to the tanking of oil prices. The unemployment rate, 7.9 percent in 2012 and 6.7 percent in 2013, dropped below 6 percent in 2014. The economy is doing pretty well in the aggregate.

Stocks were up solidly again in 2014, if not by as much as in 2013, continuing a mostly uninterrupted upward run since March of 2009. The Dow ended the year up 7.52 percent while the Nasdaq and the S&P 500 rose 13.40 percent and 11.39 percent (13.7 percent if dividends are included), respectively, for the year. The S&P is now up an average of 20.7 percent a year for the last three years including dividends, its best three-year return since the late 1990s.

Meanwhile, the bond market performed well too. Whether we’re looking at bonds in the aggregate (AGG was up 6.00 percent on the year) or at various component parts (LQD, representing corporate bonds, produced an 8.2 percent return, while EDV, a decent proxy for long-duration U.S. Treasuries, gained a whopping 45.10 percent in 2014), fixed income had a pretty good year too. Commodities (especially oil, obviously – after hitting a peak around $107 a barrel in June, U.S. crude oil futures finished the year at $53.27) did very poorly, while European stocks and emerging markets were spotty, but that’s mostly quibbling.

More broadly (as Steven Pinker, among others, persuasively argues), in many ways the current world is a huge improvement over what came before. Statistically speaking, tribal warfare was nine times as deadly as war and genocide was even in the 20th century, despite its concentration camps, gulags and killing fields. The murder rate of Medieval Europe was more than thirty times what it is today. Slavery, excessive and sadistic punishments, as well as frivolous executions were unexceptionable features of life for millennia, but are quickly disappearing today (if not nearly quickly enough). Wars between developed countries have all but vanished, and even in the developing world, warfare kills but a fraction of the people it did just a few decades ago. Rape, assault, hate crimes, deadly riots, child abuse and more are all substantially less common than they once were. Hunger has been halved in the developing world since 1990. Disease is waning dramatically, allowing most of us to live longer. Things are a long ways from perfect and plenty of problems exist, but the overall picture isn’t half-bad. Not many of us would jump at the chance to switch places with those who lived during other times or eras.

All of which brings me to yesterday. Continue reading

An End-of-the-Year Best-of Top Ten

AboveTheMarket_MeaningEnd-of-the-year best-of lists are an internet staple. Who am I to argue with tradition, especially at Christmas?! So here’s an Above the Market Top Ten of a slightly different sort (not to mention that I have included 11 posts, adding one for good luck). First, here are the top three 2014 posts (by readership) at ATM this year.

Here are ATM’s five all-time most popular posts.

And, finally, here are three posts I think are particularly important if not quite so popular.

I hope you will read them…or read them again. Merry Christmas and Happy New Year to all.