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What’s the Shape of Your Recession?

What’s the Shape of Your Recession?

Courtesy of Tim at Psy-Fi Blog

Man Using Binoculars

Clueless Commentators

Over the past few years we’ve had endless economic experts opining on the nature of the recession. From initial hopes of a bouncy V shaped recovery we moved onto a sluggish U and then a very droopy looking L before a dose of government pump-primed financial Viagra re-erected the idea of the V. More pessimistic predictors – mainly those who originally plumped for a U or an L – are now hopefully suggesting that we’ll get a double-dip W or a triple-dip VW in an attempt to save their remaining credibility.

Of course, the reality is that none of them have the faintest clue because none them possibly can have the faintest clue. We are, as always, in the uncharted waters of the future. The only letter that needs apply is the X that marks the spot where we bury the commentators and their useless predictions.

Blithe Ignorance

Right Idea! Wrong Planet! with trash can

As we’ve sailed on through the treacherous shoals of economic uncertainty people have naturally looked to the world’s experts for advice. Occasional suggestions by central bankers, who actually have the real data to analyse, that they don’t have a clue what’s going to happen have resulted in shudders across world markets. Meanwhile commentators have happily carried on making essentially random predictions based on their thirty years or so experience of largely benign economic times. It’s like watching a weather forecaster from Hawaii trying to make predictions for the Mid-West: amusing, but not terribly helpful.

In fact, as economies have uncertainly recovered we’ve seen the standard reactions by experts who’ve been caught out (see You Can’t Trust The Experts With Your Investments). Many have simply ignored the fact that they were wrong and have blithely continued to make further predictions; presumably on the grounds that yesterday’s media makes tomorrow’s lining for kitty litter trays. Others have opted for the standard “I was right, but not yet” or “I was wrong, but for the right reason” responses as though getting your timing wrong about the world economy and causing people to flee into overpriced government bonds just as the biggest stockmarket rally in history kicked off is a normal sized mistake.

The highly respected John Authers of the Financial Times is one of the few who’s come out and admitted he got it wrong (which is one of the reasons he’s respected). However, the one point he should have made, but didn’t, in "OK I called the rally wrong" is that picking the trends that were important is easy with hindsight but was impossible to do with certainty at the time.

The Two Rules of Ignorance

Still, a few rare experts called it right, at least temporarily, and their opinions are increasingly and eagerly sought. The problem is that simply being right last time is no proof that they can get it right next time. In investment, of course, next time is the only time that matters – hindsight is a perfectly useless investment tool.

Unfortunately we’re at least partially programmed to look for advice from experts. In an increasingly complex world we know, as a proportion of total knowledge, less and less. We’re four hundred years past the time when one person could hope to know everything yet many of the decisions we’re called upon to make are horribly complicated and not having a guide to help us is impossible much of the time.

There are, roughly, two loose rules humans follow when called upon to make decisions that lie outside of our area of expertise. One is to follow the crowd, the other is to follow the expert. Both are decent shortcuts much of the time, both are highly dangerous in investment.

Herding

sheep in Spain

Following the crowd, although much derided, is a perfectly good strategy in lots of circumstances. Doing what everyone else is doing in an unfamiliar setting is as good an approach as any. If everyone else is eating the dodgy looking purple mush then it’s a safe bet it’s not poisonous – although there’s no guarantee it’s not disgusting (trust me, it was really disgusting). Herd following has a long and honourable history, and is certainly evolutionarily adaptive – children habitually copy their parents and other adults in order to learn more advanced behaviours. You know, stuff like getting drunk, betting on lame horses, buying overpriced property and reading magazine articles on talentless micro-celebrities who’ve the star quality of a dead skunk.

Of course, in individual investing, herding is often the wrong thing to do assuming that we’re trying to maximise our wealth. Although, it should be noted, the momentum effect – where shares that have gained continue to do so and losers continue to fail – is extremely persistent. The problem with this is that shares do, eventually, tend to mean revert and that usually catches the crowd unawares.

Ask The Expert

The alternative, to ask the expert, is also a method with a decent pedigree. In science based areas where there’s a dispute it’s a reasonable rule of thumb to go with the side that has the most experts, although not everyone completely agrees as David Coady sets out in When Experts Disagree. For most of us this has the most direct impact in medical matters. So, for instance, in the recent debates over whether the MMR jab could cause autism the vast weight of the establishment came down in favour of children having the inoculation. The dangers of not having it were real, the dangers of taking it uncertain and the risks, as usual, were exaggerated by the headline obsessed media.

Unfortunately experts aren’t always right. The advice of the child-rearing expert Dr. Spock to lay babies on their stomachs is now the exact obvious of the expert opinion in regards to cot-death. As Ben Goldacre has repeatedly written about on his Bad Science blog, pharmaceutical funded research consistently shows a bias in favour of positive results that isn’t seen in independently funded studies. This isn’t evidence of deliberate bias by the researchers, however, since we’ve seen before how unconscious psychological drivers can lead to this type of reporting.

Investment Advice

In non-scientific areas of research, like investment, the problem is much harder. The issue is that we’re not dealing with matters of fact but with matters of opinion. Mostly there is simply no consensus to base a decision on and we tend to gravitate to the expert who’s been most recently right. Unfortunately, if expert opinion is truly random then the most recently correct experts are probably those least likely to be right in future. But in truth, we don’t know.

So in financial matters our two most favoured short-cuts in areas of specialist expertise are almost bound to leave us in the lurch. Of course, mostly we follow these routes so automatically that we’ll go ahead and use them anyway, like a driver following a sat-nav over a cliff edge. The alternative is to try and acquire sufficient knowledge to do the job ourselves and here we tend to fall victim to a different bias – the idea that because it’s easy to do something it’s easy to do it well.

Simply being able to log on to a sharedealing site, purchase a few shares and see them roar is no evidence at all of investment expertise. In fact, there’s a good case for arguing that the easier it is to get access to a means of making money the harder it actually is to do so. Consider blogging, an activity engaged in by everyone from five year old toy collectors to octogenarian needle workers. Anyone can do it, which means making money from it is virtually impossible for new entrants: that’s the nature of basic economics.

Good Enough Expertise

As so often the best advice in this area comes from Charlie Munger who observes that in order to make difficult technical decisions you need to employ an expert and then gain sufficient knowledge personally to at least cross-check that they know what they’re doing. In investment that roughly equates to them not chasing every trend, not trusting research done by others and having a clear understanding of the fundamentals of valuation techniques and competitive advantage.

For the most part, though, you don’t want an expert who spends their time opining on the shape of nebulous concepts like recessions. Better find one that actually spends some time thinking.

Related Articles: Technical Analysis, Killed By Popularity, Ambiguity Aversion: Investing Under Conditions of Uncertainty, You Can’t Trust The Experts With Your Investments
 

 


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