Experts Fail To Predict The Market – Look for Outliers Next Time

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.

Continuing to Crowdsource the Future of Investing

For those familiar with the al Qaeda Strategy 2011-2012 survey and Post-Bin Laden Poll, you may have also seen the “Future of Investing” challenge I ran a few months back.  The idea was to see if the same crowdsourcing approach, which proved helpful in gathering expert opinions for what the future of terrorism would look like, might also be able to collectively forecast the future of investing in a time of economic turmoil.

Today, the Bureau of Labor Statistics announced another decrease in unemployment suggesting there could be some renewed confidence coming into investment markets.  I saw this as another opportunity to re-post the Crowdsourcing the Future of Investing survey and see what people think about the economy compared to perceptions a few months back.

Thanks to all those that voted in the October round of the survey and for those just hearing about the survey, click the below link and answer the six questions (which take about 3 minutes).

Future of Investing Survey

Here’s a sample of the survey and its first question.

Al Qaeda: Where’s the money? – Not Dead, but Dying, Part 2

Newsweek recently published an update from their al Qaeda source, Hafiz Hanif, an intermittent al Qaeda cell member who recently tried to rejoin his group North Waziristan.  The article entitled, “Al Qaeda on the Ropes, One Fighter’s Inside Story” is a followup to a previous 2010 interview with Hanif entitled “Inside al Qaeda“.  A great read for those interested in AQ’s demise.  There’s so much in this article that I could write about but today I’m just going to focus on one thing – MONEY.

Many perpetuated the notion immediately after 9/11 that terrorism and al Qaeda’s brand in particular costs very little.  Common analysis peddled via TV news based this measure on the fact that the 9/11 attacks cost only a few hundred thousand dollars to execute yet caused such tremendous damage.  The mistake of this argument arises from analysts confusing the production costs of one attack (9/11/2001) representing the total cost of all al Qaeda operations.  Not so! While the individual attack appears cost effective on a case-by-case basis, operating al Qaeda’s global infrastructure requires millions of dollars every year.  Al Qaeda, throughout their history, has struggled at times to maintain financial support and distribute funding equitably (See Harmony & Disharmony and AQ’s (Mis)Adventures for examples).

No one likes having a friend/guest sleep on your couch and eat all your food for ten years without chipping in on the bill – especially when your friend brings drone missile attacks on your house.  Al Qaeda has likely spent hundreds of millions of dollars over the past decade maintaining its safe haven and routinely shifts large amounts of resources to Taliban groups for protection.  These funds came predominately from wealthy Gulf donors and hinged largely on the connections, image and reputation of Bin Laden – a leader from the Arabian Peninsula.

The recent Newsweek article paints a sad picture of al Qaeda Central’s state in Pakistan and more importantly their financial state.  Here’s an updated report from Hanif related to al Qaeda’s financial situation:

New recruits have stopped coming, Hanif says. “When new people came they brought new blood, enthusiasm, and money. All that has been lost.” The money may be a bigger problem than the manpower, he (Hanif) says. Al Qaeda used to receive millions of dollars a year from Arabian Gulf contributors, but Hanif’s uncle says his contacts tell him the donations have dried up. Instead, he believes, the money is going to the more productive and generally nonviolent Arab Spring movements in North Africa, Syria, and Yemen. “I think Arab people now think the fight should be political at home and not terrorism aimed at the West,” says the uncle. “The peaceful struggle on Arab streets has accomplished more than bin Laden and Zawahiri ever have.”

and

Hanif recalls how al Qaeda logistics operatives used to visit his unit to ask what the men needed in terms of weapons, medicine, food, and money. And he used to love making supply runs to the bazaar in North Waziristan’s capital, Miran Shah, with pockets full of cash for sweets and tea and to use the Internet. The town is still thronged with Pakistani and Afghan Taliban, shopping side by side with Pakistani soldiers, but now the Arabs have mostly vanished, and the shops specializing in olive oil, Arabian dates, and other Arab favorites are deserted or closed. Fighters subsist on minimal rations—if they aren’t left to fend for them-selves. That’s not easy, since al Qaeda has few friends in the area. Villagers fear that bin Laden’s men could bring drone strikes and the danger of civilian casualties, and al Qaeda has nothing left to offer local militants. The group is broke, and most of its best explosives and technical specialists have either died or left the vicinity. There aren’t even enough fighters left to act as reinforcements

During the AQ Strategy poll and Post-UBL poll in April/May 2011, I asked where will Gulf donor contributions go after UBL’s death.  Most thought donor support to AQ Central in AFPAK would be sustained.  However, ‘Private Sector’ respondents indicated that Islamist groups amongst the Arab uprisings would be the new investment priority.  It appears the ‘Private Sector’ voters may have been the most accurate in their prediction and suggests that if you want to know who will invest and where – ask the private sector as their success or failure hinges on picking winners.

As for me, for now, I’m sticking with my assessment from almost one year ago today – January 16, 2011 – entitled “Thoughts against Zawahiri’s ascension”:

1) Resources

However, UBL’s greatest strength in AQ (since its inception) is distributing money and providing an architecture (The Base) from which to pursue global jihad.  I refer back to page 197 of The Looming Tower where Larry Wright discusses how, “the camaraderie that sustained the men of al-Qaeda rested on the financial security that bin Laden provided,”  In the beginning, UBL used his own wealth to support AQ.  Today, UBL’s presence in AQ brings donations from the Gulf, fund transfers from affiliates like AQIM who divert kidnapping revenues (seen reports to this but can’t confirm it), and the benevolence of the Haqqani network.  We should also remember that Zawahiri came to UBL because of his resources.  When UBL dies, Zawahiri may take control but he will not be able to secure these three resource pipelines.

Here’s a re-post of the graph from the Gulf donor support question the week prior to Bin Laden’s death (AQ Strategy Poll):

 

And here’s a graph from the same Gulf donor question the week after Bin Laden’s death (Post UBL Poll):

 

Crowdsourcing the Future of Investment Management

Thanks to the contributions of SelectedWisdom.com readers during the AQ Strategy 2011-2012 and Post Bin Laden crowdsourcing surveys, I’ve recently taken on a new challenge to see if the same methodology can be used to provide useful insights on an entirely separate industry – investment management.

Two weeks ago, I began commenting on the similar analytical challenges found in both the financial industry and the national security arena.  That research led me to create a fourth crowdsourcing poll to collectively determine the future direction of the investment management industry following another round of market shocks this past month.

So today’s challenge:

What will be the future of the investment management industry? 

The following link will take you to 6 questions (with 4 additional attribute questions) designed to take roughly 3 minutes to answer.  There are no right or wrong answers and all are welcome to participate regardless of your experience or education level.
Click here to take survey

The financial content discussed in this survey is likely a departure for most who visit SelectedWisdom.com and find largely national security discussions.  However, I challenge you to take the survey anyways and see what you think.  And if you have professional colleagues, friends or family members interested in the investment management and/or financial sector, please pass on the following link and ask for their opinion:

https://www.surveymonkey.com/s/SelectedWisdomInvestmentManagement

Thanks in advance for your time, contribution and forwarding of the survey link. Like previous crowdsourcing polls, I’ll post the results of this survey at SelectedWisdom.com in the coming weeks. Now get back to endless “10th Anniversary of 9/11″ media coverage.  (That’s what I’m going to do).

Launch of Selected Wisdom- Business, Finance and Energy

Today I am launching Selected Wisdom- Business, Finance and Energy.  Over the past several years, I’ve found great insights from business case studies and economics research.  When I encounter peers in the private sector, I’m often surprised how their challenges in organizational management, logistics, human resource management and strategic vision mirror that of both terrorist organizations and counterterrorism bureaucracies.  Likewise, I’ve overlapped on several occasions with research endeavors in the financial and energy sectors.  Their quantitative and qualitative analytical techniques utilize similar modeling and information aggregation methodologies to those employed in national security analysis.  Financial and energy sector companies, much like their public sector counterparts in government, face the same obstacles in assessing and utilizing expert judgement- a topic of particular interest at Selected Wisdom. If all goes as planned, I’ll soon try to utilize the crowdsourcing methodology used here at Selected Wisdom (for assessing AQ’s strategy) in a similar fashion in the financial and energy sectors.  More to come on that front in the coming days.

I’ll begin making short posts on the Business, Finance and Energy page from time to time as I find interesting commentary and unique insights.  If I think the international affairs/national security/counterterrorism audience might be interested as well, I’ll do a quick redirecting post on the main page.