Certainty about the Past and the Future
This past July I wrote to our clients the following about the upcoming election: “This election is, to put it mildly, unusual. A protracted, inconclusive, drawn-out election, accompanied by demonstrations and riots, will no doubt spook the market. But we are operating on the assumption that this will be a short-term problem, and the uncertainty and volatility of even this election cycle will eventually be resolved.”
Reading this now, it would be tempting – and also extremely foolish – to brag and say “Wow! Look at that! Wasn’t I smart!”
The truth is I was lucky. I did not know how events would unfold. Along with many others, I certainly did not anticipate an election that would be decided that same night. In fact, prior to the presidential election, I spoke with several clients about the volatility that might erupt in the financial markets if 1) Trump lost and contested the election 2) Trump won and there was civic unrest in major cities or 3) the election was so close that there was no clear winner, followed by months of litigation, rising tensions, and dangerous accusations of trying to steal the election.
It may now appear obvious that the presidential election would be resolved that same night, and that the country would be spared weeks or months of court cases, recounts, and rising political tension, and that the market (the S&P 500) would respond with a burst of ebullience in the form of a 4% rise during the last three weeks of November, but if we think back and try to remember how we felt on November 4th we will remember that all of this was anything but obvious.
Only in hindsight does everything seem obvious. For example, when we look back it seems inevitable that the North would win the Civil War, that the Allies would win WWII, and that the Soviet Union would collapse ending the Cold War in 1989, but to those living in 1860, 1941 or 1950, none of these outcomes was obvious, and there was tremendous fear and uncertainty amongst the populace about what might result from these conflicts. Sometimes that fear and uncertainty led to awful occurrences, such as the internment of the Japanese during WWII or the McCarthy blacklists at the outset of the cold war.
How does this relate to investments? The very same tendency to look at historical events as inevitable and obvious in retrospect, also applies when we look at investment results.
For example, for the last 5-10 years, some of the smartest people in our industry have been making a very reasonable argument that international stocks are more attractively valued than U.S. stocks, and that a properly diversified portfolio should have an allocation to international that is at least equal to a market weight allocation (which is approximately 37%). See here, for example: https://www.etf.com/sections/index-investor-corner/swedroe-bias-can-derail-you. Other market participants have pointed out that since 1975 the outperformance of U.S. stocks over international stocks lasts, on average, about 8 years, but this current cycle has lasted 13.6 years. https://www.hartfordfunds.com/dam/en/docs/pub/whitepapers/CCWP014.pdf
Looking backwards, we can see that these investors have been painfully wrong, as U.S. stocks have failed to follow the typical script. Observers can fool themselves into thinking that any investor who over weighted or even used market weights of international made an obvious and foolish mistake. But that is hindsight bias, and it reflects on the observer not the investor.
Another, and the most well-known example, of hindsight bias involves the growth/value debate. For over a decade, value investors have been arguing that the continued outperformance of growth over value could not continue. The valuations no longer made any sense. Value stocks were cheaper than at any other time in financial history. https://www.institutionalinvestor.com/article/2bsworb4cn8xkpjtsk6ww/portfolio/cliff-asness-has-once-again-come-to-values-defense
There are many extremely smart, well-respected investment professionals who have spent their entire careers pursuing a value approach to investing. They suffered painfully during the tech bubble of the late 1990’s but were vindicated during the years 2000 through 2002, when the bubble burst and value proved its worth. But nothing compares to the pain they have experienced during the last 14 years, with layoffs and outright failures. Only investors who specialize in growth investing would say that this was all obvious.
If you kept money on the sidelines during the run-up to this past election, do not punish yourself. Similarly, if you did not keep money on the sidelines, don’t congratulate yourself, either. Rather, remind yourself of what you thought before the outcome became obvious, and judge yourself on your decision-making process, and not on the outcome.
In a speech at the Philadelphia Bar Association’s Bicentennial Dinner on March 12, 2002, the American historian David McCullough offered these eloquent words:
“……nothing ever had to happen the way it happened. Ever. Nothing is pre-ordained. Not in the life of a nation, not in the life of an individual. Any past event could have gone off in any number of different directions for any number of reasons, anywhere along the line. And that’s very hard to convey when teaching history or writing history, or perhaps presenting a case before a jury.
There was nothing whatever to say that this country would succeed. Nothing whatever to say that this little city, in 1776, could have produced the people that it produced. There was nothing ever to say that we would defeat the Nazi machine. There was never anything to say there would be a Thomas Jefferson, or a John Adams. Or a Theodore Roosevelt, or a Franklin Roosevelt.”
Once you know the outcome of something, it is hard to remember that only a short time ago the path forward was actually quite uncertain.
The brutal truth of life is that we are “stuck with uncertainty” when it comes to looking forward and, perhaps, we rebel against that fact by reflecting onto the past a certainty as to outcomes that did not exist at the time, and that will never exist in the future.
Only looking backward does the trajectory of financial markets, or any important historical event, look obvious and inevitable.
We wish all of you a holiday season of rest, relaxation, joy, and meaningful time with family. On to 2025, whatever it may bring.
