A Broken Clock That’s Right Only Once

Dalio
Ray Dalio: ‘We’re disappointed because we should have made money rather than lost money in this move the way we did in 2008’ © Reuters

In 2009 I was working for a large mutual fund company in Western Canada. It was the peak of the financial crisis and I was given the opportunity to take a promotion but had to move to Alberta. I was eager to move up (I was only 28) and jumped at the chance though I had no great desire to live in Edmonton. It was a difficult time. It was lonely in Alberta, and people weren’t eager to speak to a wet behind the ear’s wholesaler right after the biggest rout in modern financial history.

One particularly vivid memory for me was back in 2009, walking into an office at the tail end of conference call being given by Christine Hughes, a portfolio manager of some note during the crisis. Hughes was at the top of her game. She had outperformed much of the market by holding 50% cash weighting and had correctly predicted the financial crash. In later appearances she would complain that the company she worked for had prevented her from holding more and would have had been allowed to. But at this moment, in 2009, it was late summer, and markets had been rebounding for several months, having hit bottom in early March. Hughes was adamant that “the other shoe was going to drop” and that’s when things would really go wrong.

For much of my time in 2009 Hughes, and her fund, was the story that challenged me. Having made the correct call in 2008, advisors were eager to listen to what she had to say and believed that her correct prediction in 2008 meant she knew what was coming next. Many people followed Hughes and her advice, which led primarily nowhere.

Hughes’ time subsequent to 2008 was not nearly as exciting or as successful as you might have guessed. She left AGF, where she had made it big, and went on to another firm before finally starting her own company, Otterwood Capital. The last time I saw Hughes it was in 2013 and she was giving a presentation about how close we were to a near and total collapse of the global financial system. Her message hadn’t changed in the preceding four years, and to my knowledge never did.

Hughes may not have prospered as much as she hoped following her winning year, but others who made similar predictions did. One such person is Ray Dalio, the founder and manager of Bridgewater Associates. Dalio is a different creature, one with a long history on Wall Street who had built a successful business long before 2008. But 2008 was a moment that launched Dalio into the stratosphere with his “Alpha Fund” largely sidestepping the worst of that market and by 2009 his hedge fund was named the largest in the US. Since then Dalio has grown a dedicated following beyond his institutional investors, with a well watched YouTube video (How the Economic Machine Works – 13 million views) and a series of books including one on his leadership principles and a study on navigating debt crises (I, of course, own a copy!). Yet when the corona virus rolled through Dalio’s funds faired no better than many other products (I’m sorry, this is behind a paywall, but I recommend everyone have a subscription to the Financial Times). Once again past success was no indication of future returns.

I’m not trying to compare myself to a hedge fund manager like Dalio, a person undoubtably smarter than myself. However its important to remember that being right in one instance, even extreme and unpredictable events, seems to offer little insight into when they will be right again.

If you’ve read many of these posts you may know that I am a fan of Nassim Taleb, the author of The Black Swan and Antifragile. Early in the book Black Swan, Taleb makes the case that “Black Swan logic makes what you don’t know far more relevant than what you do know. Consider that many Black Swans can be caused and exacerbated by their being unexpected.” This is an important idea that I think can be extended to our portfolio mangers that gained notoriety for getting something right and then getting much else wrong.

A complaint I have long held about experts within the financial industry is both their desire to position themselves as outsiders while being likely to share many of the same views. Having a real contrarian opinion is more dangerous than being part of the herd, after all if things go wrong for you as a contrarian, they are likely to be going right for the herd. On the other hand, if things go wrong for the herd, the herd can use its size as a defense: “We were all wrong together.”

Some of this group think can be applied to the failure of governments to get a jump on the coronavirus situation. Far from not listening to experts, governments took the safest bet which was also the most conservative view, that the virus posed a low risk to the population of countries outside China. People who thought the virus was a large risk were taking a more extreme view; that the virus posed a serious risk and required extreme measures such as travel restrictions, aggressive testing, encouraging people to wear face masks and socially distance. As a politician which choice would you make?

The point for investors should be to treat the advice of financial experts who rise to prominence during outlier events as no more special than those that got big financial events wrong. This is not because their advice isn’t good, just that the thing they got right may not indicate wide ranging knowledge, but a moment when they understood something very well that other people did not. Investors should avoid personality cults and maintain a principle of uncertainty and scepticism to prophets of profit. The rise of COVID-19 and the global pandemic response, including the rapid change in the market, will produce a number of books and talking heads who will parlay their status as hedgehogs into that of a foxes! (If you don’t know what I’m referring to, please read this from 2016).

Dalio remains a very successful manager, but his correct reading of 2008 did not prepare him for 2020. In his own words: “We did not know how to navigate the virus and chose not to because we didn’t think we had an edge in trading it. So, we stayed in our positions and in retrospect we should have cut all risk.” Christine Hughes on the other hand seems to have disappeared, her fund gone and she in an early retirement. I know of no financial advisers eager to hear her views.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

The Exciting New Field of Recession Prognostication

PsychicI wish to inform you about an exciting new profession, currently accepting applicants. Accurate recession prognostication and divination is an up and coming new business that is surging in these turbulent economic times! And now is your chance to get in on the ground floor of this amazing opportunity!

I am of course being facetious, but my satire is not without precedent. As 2018 has devolved into global market chaos, finally losing the US markets in October, experts have been marshalled to tell investors why they are wrong about markets and why they should be more bullish.

Specifically analysts and various other media friendly talking heads have been trying to convey to the general public that the negative market sentiment that has driven returns down is misplaced, and have pointed to various computer screens and certain charts as proof that the economy is quite healthy and that in this moment we are not facing an imminent recession. Market returns through the final quarter of 2018 indicate this message has yet to find fertile ground among the wider public.

Dow Jones Dec 31
The Dow Jones has had a wild ride this year, with significant declines in February, October and finally in December when the markets ended the year lower than they began.

While these experts, analysts and financial reporter types may not be wrong, indeed the data they point to has some real merit, I don’t think that investors are wrong to heavily discount their advice. For the wider investing audience, being right 100% of the time is not a useful benchmark to strive towards with investments ear-marked for retirement. Instead a smarter approach is to be mindful about risks that can be ill-afforded. Investment specific risk, like that of an individual stock may be up to an investor (how much do I wish to potentially lose?). On the other hand, a global recession that is indiscriminate in the assets that suffer may be more risk than an investor can stomach.

TSX Dec 31
The S&P TSX has had another dismal year, and is currently lower than it was in 2007, marking a lost decade. Making money in the Canadian markets has been a trading game, not a buy and hold strategy.

The experts have therefore made two critical errors. The first is assuming that what is undermining investor confidence is an insufficient understanding of economic data. The second is that there is a history, any history, of market analysts, economists and journalists making accurate predictions of recessions before they happen.

This last point is of particular importance. While I began this article with some weak humor on prognostication and divination, it’s worth noting that predicting recessions has a failure rate slightly higher than your local psychic and lottery numbers. That so many people can be brought forth on such short notice to offer confident predictions about the state of world with no shame is possibly the worst element of modern investment culture that has not been reformed by the events of 2008.

2008 Predictions vs reality
These are the economist predictions for economic growth at both the start of Q3 and Q4 in 2008. Even as the collapse got worse, economists were not gifted with any extra insight. 

This doesn’t mean that investors should automatically flee the market, listen to their first doubt or react to their gut instincts. Instead this is a reminder that for the media to be useful it must think about what investors need (guidance and smart advice) and not more promotion of headline grabbing prognostication. The markets ARE down, and this reflects many realities, including economic concerns, geopolitical concerns and a host of other factors outside of an individual’s control. It is not a question of whether markets are right or wrong in this assessment, but whether good paths remain open to those depending on market returns.

In Praise of Investor Optimism

markets_1980043c

My industry is awash in optimism. This makes intuitive sense, for the entire process of investing assumes that the companies you invest in will go up in value. Regardless of how conservative and cautious a portfolio manager is, underlying his dour outlook is an optimist that runs a portfolio of various stocks, each one intended to make money.

optimism

For this reason it is incredibly rare to hear outright negativity from professionals, which I suspect contributes to a subtle sense of unease by the average Canadian who must both trust a portfolio manager to look after his money while scratching their heads at a market that can decline significantly in value with no perceivable change to the asset mix they are invested it.

This is Bill Gross. Until 2011 he was a very successful manager with PIMCO, where he headed up their largest fund. Then he made a contrarian prediction about the markets, lost a lot of money and was fired from his fund.
This is Bill Gross. Until 2011 he was a very successful manager with PIMCO, where he headed up their largest fund. Then he made a contrarian prediction about the markets, lost a lot of money and was fired from his fund.

Even when we do get very negative views from portfolio managers, the subtext is still optimism, just for THEIR investment choices. There is never a contrarian market call that doesn’t seem to serve double duty as a marketing plan as well. When Bill Gross famously said that the US was going to tank back in 2011, he was also claiming that his investments wouldn’t and took a contrarian stance that proved to be very costly for his investors. The same is true for Eric Sprott, whose own doubt about the future of stock markets had prompted some very optimistic numbers about the value of gold and junior mining companies.

For the average investor much of this can be quite exasperating as investing shies away from the ways we attempt to establish certainty. Investing is all about educated guesses, and despite many different tweaks the rules for investing remain surprisingly limited: “buy low, sell high” and “diversify”. Professionals have attempted to improve and refine how these two things are done, seeking out the best ways to analyse companies, markets and whole countries, but in the end these two rules still provide the best advice to investment success.

I wish to write to you about a mistake on your billboard...
I wish to write to you about a mistake on your billboard…

But as investment guides go, reveling in the uncertainty of the investments is something that many people don’t want. Instead they would much prefer to hear about what is going to happen in a matter-of-fact manner from an “expert”. This is why there is always a market for doomsayers and contrarian predictions, because of the certainty they seem to offer. It feeds our innate sense that there must be a right and knowable answer about the future that can be revealed to us.

sandwich-board-man-warns-us-of-impending-doomAnd yet like their biblical equivalents, contrarian predictions have all failed to live up to their hype. Just as every “end is nigh” doomsday cult has disappointedly had to move the calendar date for the end of the world, the number of people who have proclaimed loudly the end of traditional investment world is both numerous and filled with failure.

And so, frustratingly, investors are faced with the assuredness of doom-saying predictioners (who are almost certainty wrong), and the cheerfully faced optimistic portfolio managers who routinely remind investors that there is no bad time to invest, that bad markets are “corrections” or “set backs” and that significant price drops are “buying opportunities”.

And yet I doubt we would have it any other way. If we could be absolutely certain about what stocks were going up or down and when there would be no money to make in the markets as companies would always be priced correctly. And whether we realize it or not, it is hugely helpful to remember that there exists no accurate way to divine the future, no Ouija board that can contact the dead, no equation or computer that can process the world’s data to tell us what is happening tomorrow, next week or a decade from now.

I derive great comfort in this, because the optimism that drives the investing world is also a wider optimism about the future. Experts predicted famines wiping out millions in 1970s and 1980s, environmentalists predict the end of all things, and political talking heads bombard us with a daily diet that everything is awful, but our world is healthier, wealthier and kinder than ever before. And unbelievably investors believe in that world, even when they don’t know it.