The market has stumbled. I think that’s something we can all agree on. With the rise in volatility, decline in stock prices, the financial news stories can become sexy again. Special Reports can be run in financial media and the gong banging analysts can make their should-be satirical, but sadly self-believed, predictions of the next boom and bust. With this decline in financial assets, with nearly every asset class seeing some degree of red, it can be easy to fall into a pit of sound bites and a vacuum of your own market themes. Those that are extremely bullish will change their chart settings from daily to monthly and expand the time period to make the current decline look minuscule in comparison to the up trend since 1929. Uber-bears will do Twitter searches for users with the word “bubble” and “dooms and gloom” in their handles while also plotting their 1987 analogs against the latest price charts, mentally deleting their 2014, 2015, 2016, and 2017 version of failed ’87 repeats in hopes that this time will (or won’t?) be different.
We must avoid falling for these traps. I don’t argue for moving into a cave and canceling all forms of financial content, both journalistic nor amateur. But rather to be aware of the need for critical thinking. The need for being foxes in a world of hedgehogs.
Over the long Thanksgiving weekend I started to read John Lewis Gaddis’ latest book, On Grand Strategy. From the Amazon summary: “In chapters extending from the ancient world through World War II, Gaddis assesses grand strategic theory and practice in Herodotus, Thucydides, Sun Tzu, Octavian/Augustus, St. Augustine, Machiavelli, Elizabeth I, Philip II, the American Founding Fathers, Clausewitz, Tolstoy, Lincoln, Wilson, Franklin D. Roosevelt, and Isaiah Berlin.” I’m less than halfway through the book but so far it’s excellent and I can already tell it’s one I’ll be recommended to anyone who asks for a new book recommendation that doesn’t involve a teen werewolf, various shades of gray, or thrones playing games.
In the first chapter of On Grand Strategy Gaddis writes about a study that was done on political predictions in an attempt to discover what separated the good from the bad predictors of future events. While the study focused on politics, I strongly believe the same conclusions can be made for financial markets. Let’s take a look at what the research found…
Gaddis describes the study conducted by Philip Tetlock: “Collected 27,451 predictions on world politics between 1988 and 2003 from 284 ‘experts’ in universities, governments, think tanks, foundations, international institutions, and the media.” The study produces its results showing why some people were more accurate than others in their predictions. The researcher found the critical variable was the identification of each predictor as a “fox” or a “hedgehog” (which gets covered in more detail in the book). Tetlock found that “foxes were more proficient predictors than hedgehogs” and went on to describe each category of predictor, which is what draws this conversation to apply, in my opinion, extremely well to the markets and the 24/7 siren song of opinions that can be found under nearly ever rock of news media, every anonymous and verified Twitter user, and blogger who wishes to share their expert or barely third grade level thoughts on whatever topic they’d like to pontificate.
Tetlock described foxes, who were found to be more accurate predictors of political events and outcomes, to rely more on their “intuitive ‘stitching together of diverse sources of information,’ not on deductions derived from ‘grand schemes.’ […] The best of them ‘shared a self-deprecating style of thinking’ that ‘elevated no thought above criticism.’ but they tended to be too discursive – too inclined to qualify their claims – to hold an audience.” Meaning political foxes, and by commonality, financial foxes, rely on critical thinking and process discovery to root out their eventual opinion, allowing for the chance their initial beliefs could be wrong. However, relying too heavily on data and quantification of their beliefs they rarely make for good news stories or interviews as their “entertainment” value isn’t as high as that of a hedgehog.
Now as far as political hedgehogs go, who they found to be less accurate in their political predictions… “shunned self-deprecation and brushed aside criticism. […] They became ‘prisoners of their preconceptions,’ trapped in cycles of self-congratulation. These played well as sound bites, but bore little relationship to what subsequently occurred.”
The study concluded that “‘a theory of good judgement’: that ‘self-critical thinkers are better at figuring out the contradictory dynamics of evolving situations, more circumspect about their forecasting prowess, more accurate in recalling mistakes, less prone to rationalize those mistakes, more likely to update their beliefs in a timely fashion, and – as a cumulative result of these advantages – better positions to affix realistic probabilities in the next round of events.” I’m not arguing that bulls are foxes or bears are hedgehogs nor am I saying that ones side of the financial equation is more correct than the other. Both camps have their own mixes of foxes and hedgehogs.
Are you a fox or a hedgehog? Gaddis writes that we are both, wearing the hat of a fox at different times and one of a hedgehog at others. There are some (especially in the political arena) that have adopted the character of a hedgehog, practically banning themselves from ever resembling a fox. They prefer to grasp their self-created notion of how the world works, how the markets move, how humans act, and how investors should respond, plugging their ears to new information and shutting their eyes to any contradicting facts.
You have a choice. You can choose whose content you digest, whose opinion you allow yourself to be influenced by, and you control the mediums of data that shape your investment process. It’s often said that you are a result of those you chose to spend time with. Spend too much time with financial hedgehogs and that’s what you’ll likely become. As salacious as some of the headlines they bring may appear, it’s the foxes that will survive in the long run. The foxes are who will come out the other end of bear markets, flash crashes, economic recessions, geopolitical wars, and the barrage of tweets, blog posts, news stories, and DMs thrown their way. Which do you find yourself spending more time reading and digesting content from, those that “prisoners of their preconceptions” or those that “elevate no thought above criticism”?
Taking the mindset of a fox and allowing opinions to be fluid can be helpful in navigating the current down trend and allow you to stay nimble, potentially more accurate in your reasoning (as the above study discovered) and prepared for whatever the market throws your way.
Source: On Grand Strategy by John Lewis Gaddis
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