Updated: 27 January 2013
Experts Fail To Predict The Markets – 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.
Updated: 3 February 2012
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:
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).
Updated: 3 September 2012
Importance of Confidence: In Conflict and Markets
From about 2005-2007, military briefings pushed me to the edge of a coma with endless banter about how counterinsurgency victory depends on the “will of the people to outlast the insurgents”. The briefer would then show a chart depicting the average length of insurgencies and how popular support for the counterinsurgents determined the outcome of the conflict. Essentially, if the population supporting the counterinsurgency were confident that victory could be achieved and the cause worthwhile, then the fight could be sustained and victory attained. (There was a little more to it than confidence, but I’ll summarize to save you the pain.)
Recently, I listened to an interesting NPR broadcast on the shaken confidence of young investors entering the financial market – “How Recession Rewires Your Tolerance for Risk”. Essentially, young workers do not share the confidence of their 1990’s predecessors who believed that investing in stocks and mutual funds would provide guaranteed payments during retirement. The large scale of American worker investment contributions in mutual funds, 401K’s, and stocks helped propel U.S. market growth from the 1990’s through 2008. What will happen to the markets if the next generation of American workers chooses not to pursue this investment approach while retirees begin pulling their retirement payments out in mass?
In both cases, conflicts and markets, the tipping point for victory or growth may rest on confidence more than anything. In Iraq, American confidence helped lead to what is perceived by most as a victory of sorts. In Afghanistan, American confidence appears quelled and victory still uncertain. In the markets, I wonder when will investor confidence return and what will make it return? And when comparing conflicts and markets, I wonder which is easier, building American confidence in support of counterinsurgency or restoring American confidence in investing.
Update: 23 Aug 2011
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.