Today, I thought I’d take a break from discussing terrorism and focus on other complex challenges – economic markets. In the U.S., we are encouraged to invest in financial markets as a way to plan for retirement. In fact, at one time, a U.S. president proposed the idea of eliminating social security payments for retirees and instead giving Americans a stake in the markets as a substitute. The idea seems sound in theory, and as Dr. Daniel Kahneman pointed out in “Thinking Fast and Slow” and more recently Nate Silver captured in “The Signal and the Noise”, if one invest in the market for the long-run by simply buying index funds tied to the market average, then one is likely to make solid earnings for retirement assuming the market behaves in the future the way it did in the past.
Well, many financial experts work hard to try and beat the market and earn their investors returns greater than the market. Like experts in other fields, namely terrorism, the track record for beating the market is really bad. In 2012, the experts missed the market by a lot. The recent Bloomberg article, “Almost All Of Wall Street Got 2012 Market Calls Wrong”, reinforces why it will be outliers not the majority that will accurately predict the future in complex systems.
“The ill-timed advice [of financial experts] shows that even the largest banks and most-successful investors failed to anticipate how government actions would influence markets. Unprecedented central bank stimulus in the U.S. and Europe sparked a 16 percent gain in the S&P 500 including dividends, led to a 23 percent drop in the Chicago Board Options Exchange Volatility Index, paid investors in Greek debt 78 percent and gave Treasuries a 2.2 percent return even after Warren Buffett called bonds “dangerous.”
Why did they miss the call? Many biases and heuristics emerged to have the experts miss – most notably status quo bias (a belief that tomorrow will be like the past). With economic markets performing poorly in recent years, they continued to predict doom. They also overvalued, unimportant distracting news stories pulling them away from fundamentals.
“They paid too much attention to the fear du jour,” Jeffrey Saut, who helps oversee about $350 billion as the chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said by phone on Jan. 2. “They were worrying about a dysfunctional government in the U.S. They were worried about the euro quake and the implosion of Greece and Portugal. Instead of looking at what’s going on around them, they were letting these macro events cause fear to creep into the equation.”
Essentially, the ‘hedgehog’ experts strayed from the strength of their economic knowledge and drifted into politics. They paid for their drift.
“It’s always more challenging for investors to try and predict political actions,” Khiem Do, the head of Asian multi- asset strategy at Baring Asset Management, which oversees about $50 billion worldwide, said in a Jan. 2 phone interview from Hong Kong. “In general they’re trained to analyze the economic data, balance sheets and so on. They’re not trained to predict political decisions. These factors have ruled the lives of fund managers in a more significant manner than what used to be over the past 20 or 30 years.”
So don’t feel bad political forecasters, the financial experts have trouble predicting politics and international affairs too.