And the Beat Goes On
A group of economists was skiing at Winter Park last weekend. They were helplessly lost. One studied the trail map furiously and proudly exclaimed to the others, "I found us!"
The other economists questioned him excitedly, "Where are we?"
"You see that mountain over there," said the wise economist, "according to the map, we're on top of it."
I love the weather in Winter Park. It's a hot, dry March. If we have another two weeks like the past two, the ski areas may close. So why would a ski lover love hot weather? It gives the locals something to talk about other than the crowds. We look at the recent trend and forecast it out into the future, forever, and when we do so, things (almost always) look dire!
We do the same thing with our investments. We look at the recent performance, especially when we are in the middle of another (always only) temporary, completely mundane, stock market pull-back and say something like, "If things keep up like this, we'll be bankrupt!"
The people in white coats call this "recency bias". It is psychological, normal and it is a problem for investors. Perhaps, when homo-sapiens were commonly attacked by sabre-toothed tigers, recency bias kept us out of the dangerous parts of the jungle. But today, recency bias can be a killer.
Just think about the weather. Over the holidays it was so cold in Winter Park the town had to import plumbers from Denver to fix all the broken pipes. We came out of the month thinking that, if trends continue, we would need new parkas. February, as I recall, was the coldest on record in Denver. From the coldest month to a hot, dry month; how quickly we forget our recency bias.
Here is a prediction: the economists will find their way off the top of the mountain, with or without the map. Summer will be warmer than winter. Stocks will deliver the best potential return, over long periods of time, of any other asset class. And don't even ask me about interest rates.