You Should Listen to the Smart People, Right?

An old article from the New York Magazine made the rounds on Twitter last week titled “Strike up the bonds.” It was originally written in 1992 and it covered the economic uncertainty that existed at that time.

Here are some excerpts:

“The economy may, in fact, be stuck in a rarefied zone somewhere between recession and recovery,” says a recent report from Wall Street’s Morgan Stanley & Co.

How did this happen? In the words of Ray Dalio, president and chief investment strategist for the Bridgewater Group, the economy has become so “saturated with debt,” that all the Fed stimulation in the world may not bring about more than mediocre increase in actual borrowing and spending.

Add it all up and a pessimist might conclude that, since there are no levers to be pulled to speed up the recovery, the nineties hardly are off to a rip-roaring start.

Over the long term, both Dalio and Jones agree, as a result of these circumstances bonds in the nineties will almost certainly outperform stocks.

Ah, the joys of being able to use hindsight to look at a certain forecast from the past.

Does any of the information from that article sound similar to today’s current state of affairs? Too much debt. Check. Not enough that the Fed can do to help. Check. Weak recovery. Check.

So what actually happened?

The rest of the 1990s turned out to be one of the best periods of economic and stock market growth ever.

From 1992 on, the total US bond market returned a respectable 66.1% or about 6.5% a year. Right now most investors would kill for a 6.5% annual return in bonds. But over that same time frame, the S&P 500 was up over 320% or 19.7% per year.

This would have turned $10,000 into less than $17,000 in bonds but over $42,000 in stocks.

Now, this post is not about rubbing a bad forecast in the face of the author of this article or Ray Dalio. Ray Dalio is one of the greatest investors of all-time, generating 14-15% returns for his investors over 30+ years in the business. He is by far one of the smartest investors ever.

In fact, based on his fund’s returns, he obviously changed his thinking as the circumstances changed. The ability to change your mind as the facts change is a trait shared by all great investors. Einstein once said, “The measure of intelligence is the ability to change.”

Investors get in trouble when they hear an intelligent person give an intelligent prediction on the markets or the economy without understanding that these forecasts can and do change.

When you hear expert predictions, you don’t know their time horizon and they obviously don’t know yours so this can lead to a further misalignment of information.

Dalio also relies on rules-based systems, diversification and rebalancing to increase his firm’s returns. He has earned the right to be wrong every once and a while but he’s not alone.

PIMCO, the giant bond fund manager, comes out with long term forecasts for the economy and financial markets once a year and these forecasts come from some of the smartest minds in the investment industry.

They even coined the phrase new normal to describe the current economic malaise. They predicted that following the debt crash in 2008/09 that we would experience a sluggish recovery in the economy with slower than average growth for a number of years.

And they have been spot on with that call. Things turned out almost exactly as PIMCO predicted when it comes to economic conditions.

But they also predicted that the new normal would lead to disappointing and below average investment returns on stocks. This call was dead wrong as stocks have enjoyed one of their greatest bull market runs ever.

I’m not saying we are setting up for a raging economic recovery and a continuing of 20% returns in the stock market like we saw in the 1990s, but you should understand that no one knows how things will work out, no matter how certain they sound or how intelligent they are.

Could investors have predicted the technological progress that would be made throughout the rest of the 90s with the Internet exploding onto the scene? Obviously not.

Uncertainty works both ways. It can be scary, but things can also turn out much better than anyone expects. Again, this is not a prediction of things to come. I’m just saying that those who right now are certain of a particular outcome will probably be blindsided by an event or trend that they are not currently forecasting.

This is especially true when trying to decipher complex global economies and markets.

It feels comfortable to listen to someone intelligent make a claim about the future because we despise uncertainty. The more confident they are the better, but confidence doesn’t equate to accuracy.

The lesson here is that it’s a fool’s errand to try to use predictions on the state of the economy to shape your investment plan. By all means, keep up with what’s going on to keep things in perspective. But to paraphrase Warren Buffett, even if you could predict what the economy is going to do you still might not know what exactly to invest in.

Wesley Gray at the Turnkey Analyst blog recently shared his thinking on listening to smart people:

“I’ve made a new rule: listen to really smart people, since it is entertaining, makes me feel more intelligent, and gives me overconfidence for multiple predictions; however, avoid trading based on the projections of highly confident smart people.”

Sounds like a good rule of thumb to me.

Strike Up the Bonds (New York Magazine)
Follow the (confident) smart guys? (Turnkey Analyst)

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