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What Should Really Guide Your Investment Thinking in 2018

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A year-end review seems like a sensible way to prepare for the new year. It’s a descendant of a long cultural tradition that goes back to Socrates who said, “An unexamined life is not worth living.” 

Twenty-four centuries later, the annual review is a staple of print and digital media. 

In its most familiar form it summarizes news stories still fresh in our mind and provides commentary on the implications those stories have for the coming year. Sometimes the review will go out on a limb and make specific predictions. 

Byron Wein’s “Ten Surprises,” highly anticipated for over 30 years is my personal favorite.

Wein is an experienced observer of the world of investing. His “surprises: are thoughtful and compelling. But locating statistics about his track record was not easy. 

After collecting enough data, I understood why — the results were unimpressive.  He’s correct only 20-30% of the time.

While that says nothing about Wein’s intellect or his industry credentials, it says everything about the impossibility of making accurate predictions. 

Investment manager Joel Tillinghast reminds us that Lord Keynes publicly threw in the towel on prediction: “If the greatest macroeconomist ever, with special access to information and policy makers, couldn’t trade successfully on credit and business cycles, I don’t know who can.”

If the idea of a year-end review seems sensible and practical, perhaps we need to rethink what that review should look like. 

New Thinking

Tillinghast lays out both the challenge and the trap: Investing forces you to reach conclusions with inadequate data.  No wonder we choose based on the information right in front of us, neglecting evidence we can’t see, or latch onto a well-told story rather than digging into complexity.” 

Tillinghast was writing for investors, but his observation could apply to anyone.

C.D. Walcott was one of the most renowned and respected scientists of his time: paleontologist, advisor to four presidents, and head of the Smithsonian Institution. Even as he travelled in the highest circles, with influence over powerful and wealthy men, his first love was science.

Walcott had been traveling to the Canadian Rockies for years collecting fossils when he came across a site in the Burgess Pass in 1909. In that one small area, not much longer than a city block, Wolcott collected 65,000 specimens. 

Nearly eighty years later, Stephen Jay Gould wrote of Walcott’s discovery: “The invertebrates of the Burgess Shale…are the world’s most important animal fossils.” 

The fossils date from just after the start of the Cambrian Explosion: the wild and wooly flowering of multi-cellular life some 570 million years ago. The fossils were unique not just for their variety and detail, but for the story they told about the nature of history. 

Wolcott died never realizing the magnitude of his discovery. Why did this brilliant and devoted scientist not see what was right in front of him?

I’m attracted to year-end reviews and predictions for the same reason everyone else is: They offer hope that uncertainty can be eliminated.

We know that there are lessons to be gained from studying history, so what’s the concern?

By focusing on such a short period, the year-end review fosters a mindset vulnerable to “recency bias.”

Because the history we’re reviewing is still fresh in our minds, it feels more important than something that is far more relevant, but doesn’t feel as compelling because it’s old.

Tillinghast provides a solution: “To fix recency bias, study history – the longer and broader, the better. To envision the future, investors need some idea of the normal baseline. Discover which things change and which endure.” 

Year-end reviews are popular, but they blind us at the very time we want clarity.

Scientific Thinking

Science only makes sense within the context of a paradigm (or narrative) that explains how things work. When new information comes in, scientists plug it into the existing paradigm, and if it fits easily, it adds to our knowledge.

Sometimes new information is found that doesn’t quite fit so neatly into a paradigm, and scientists, being human, often shoehorn the data into the existing narrative rather than consider the fact that the paradigm is inadequate to explain the new stuff (and might need to be revised or even scrapped). 

Wolcott came to paleontology holding to this popular narrative: Evolution is a predictable and gradual progression from the simple to the complex. One that can be analogized to a “ladder of progress” with us (human beings) on the top rung.

The extraordinary uniqueness of the fossils notwithstanding, Wolcott did not have the time for a proper evaluation, so he shoehorned the discovery into his existing narrative and went back to his duties at the Smithsonian. The fossils gathered dust in the basement for over 50 years until three other scientists decided that they were worth a second look.

The narratives we carry with us help us make sense of the world. They help filter critical data: what is true and what is false, who can be trusted and who can’t, what is important and what is irrelevant, whether we are doing something productive or just wasting our time.

But narratives don’t have an inherent fail-safe mechanism — there are perfectly normal and functional people who hold fast to narratives built on half-truths or even complete fabrications.

What these unhinged versions teach us is that while narratives can be incredibly useful, if we are not vigilant — instead of making sense of the actual world, narratives can just as easily make sense of a make-believe one.

Harry Whittington, Derek Briggs and Simon Conway Morris did not come to Wolcott’s find with a different evolutionary narrative. Unlike Walcott, they spent nearly twenty years intensively studying the fossils. 

Gradually the narrative of a steady evolution of life, of a progression from the simplest life forms to the most complex could not explain what was emerging from the evidence.

The story told by the Burgess Shale fossils reaffirmed natural selection’s role in evolutionary science. But it added to the equation major, sometimes catastrophic extinctions. 

Life started, flowered and expanded. Species that were best suited to the environment thrived and became dominant. Then some unpredictable externality (global warming, or cooling, massive asteroid strike) changed the equation. 

Species that had thrived in one environment couldn’t survive in the next. This meant that the species dominant in today’s world are the result of a combination of natural selection and pure luck.

The narrative of a straight line of progression from simple to complex doesn’t address the reality of how life has evolved, been decimated, recovered differently in a new environment, evolved again, then decimated — at least a few dozen times.

The lesson of history imbedded within the fossils of the Burgess Shale was this: If you could rewind the tape back to the beginning of life, and rerun evolution a million times, the odds of any one of those outcomes being similar to life as we know it today is close to zero. 

That lesson gets in the way of our instinctive need for certainty and reveals the flimsiness of the simple narratives we create to make sense of the past.

In their recent book, “Cents and Sensibility,” Gary Saul Morson and Morton Schapiro explain: “That simplicity is a (sort of) historical optical illusion.  The problem is that history is full of accidents and other non-systemic factors — without which the ‘end result’ i.e., where we are today, would look very different.”

With a warped vision of the past, it’s no wonder our narratives can’t clarify the future.

Daniel Kahneman and Amos Tversky wrote: “We often decide that an outcome is extremely unlikely or impossible, because we are unable to imagine any chain of events that could cause it to occur.  The defect, often, is in our imagination.”

During my early years in the investment business, I was fortunate enough to meet some outstanding investors. None of them were famous – just regular people. 

But they shared some important characteristics.

They didn’t spend any of their time following the market, or care what my firm’s analysts thought. They invested only in things they understood. They shared a detachment from the investment world that allowed them to ignore news, market fluctuations and other distractions that vied for their attention.

It wasn’t an active choice; they were just too busy living their lives. As a result, they had the patience to wait until something resonated — and when it did, they were ready to act with confidence.

The year-end review can be a valuable and profitable exercise, or it can be a distraction that prevents us from seeing what is right in front of us. Those regular people I met years ago taught me that too much attention to investing clouds judgment — and that perspective requires distance.

If meaningful investment lessons can be distilled from the study of fossils, then a healthy imagination is the key to finding more. 

Enjoy the year-end reviews, but let personal computer pioneer Alan Kay guide you into 2018: “If you want to predict the future, invent it.”


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