What Good is History When Dealing With an Unprecedented Crisis?

I use a great deal of historical market data in my writings. This has ramped up even more than usual during the bear market.

Invariably, these posts have been met with the following comments:

Ben, you can’t compare this time to past markets. History doesn’t apply here because the economy has never completely shut down due to a pandemic. This is uncharted territory.

I get it. These statements are true. We’re living in unprecedented times.

I don’t know for sure that the economy will re-start again someday and get back on trend. I don’t know for sure how people’s behavior will be impacted when this is all over. I don’t know that stocks will react as they have in the past following brutal bear markets.

But this doesn’t mean history is useless.

On the contrary, studying history is more important than ever during a crisis. Here’s how understanding history can be helpful even during an economic calamity the likes of which we’ve never seen before:

History provides context, not answers. Understanding financial market history will never tell you what happens next. That’s why they’re called back-tests, not front-tests.

History does, however, allow you to explore the range of past outcomes to be able to apply what has happened before to the current situation.

Investors cannot predict the future but you can analyze the present and use the past to come up with reasonable probabilities when making decisions about the unknown. What other choice do we have?

History shows it’s different EVERY time. It’s not just different this time. It’s different EVERY time. Every market crash is different.

The Great Depression didn’t follow the same path as the depression of 1920-1921 just like that downturn was different than the panic of 1907.

Yet historical panics in the United States all have one thing in common — they all come to an end. Stocks recover. Economies continue to grow. People still get up every day looking to improve their station in life.

If you’re betting against the human spirit I’ll take the other side of that bet 10 times out of 10.

History shows risk is easier to predict than returns. We can’t know for sure what future returns will be for risk assets but a stroll down memory lane can help give investors a decent approximation of the potential outcomes.

One of those outcomes is the presence of risk in financial assets that seek to earn an expected return above the rate of inflation. Risk means different things to different investors but it is always there no matter what you do with your money.

And one risk for investors during the bad times is the assumption that the good times will never return.

History can help you avoid the mistakes others have made before you. Charlie Munger once said, “I believe in the discipline of mastering the best that other people have figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart.”

The inverse of this is also helpful — the discipline of avoiding the worst that people haven’t figured out in the past. And avoiding dumb mistakes is easier than emulating brilliance.

History shows life has never been easy. If there’s one thing you can learn from history it’s that humans have always lived through tough times.

I still don’t know how the world survived World War I, the 1918 Spanish Flu pandemic, the Great Depression and World War II all within the span of 30 years or so.

We humans have too many flaws to count but we are exceedingly adaptable and our ability to continue to push forward even in the face of great tragedy is not something you should take lightly.

This situation is awful but we’ve survived worse and we’ll survive this.

History isn’t perfect but I’ve yet to meet anyone who can reliably predict the future. Albert Einstein or Mark Twain or Joe Exotic once said, “I would rather be approximately right than precisely wrong.”

Every financial and investment plan involves a good deal of guessing. Those guesses should come with some baseline assumptions, be backed by sound theories and involve the use of probabilities to make decisions but the future remains unclear to everyone.

We’re all dealing with imperfect information that we build into our plans and forecasts about the future. So you work with what you’ve got, update your priors as new information comes to light, and make sure your plan is flexible enough to take new realities into account.

History has one constant. From the South Sea Bubble to the Great Depression to the inflationary bust in the 1970s to the Great Financial Crisis there is only one constant — human nature. People are people across all economic and market environments.

History shows temperament matters more for investors than intelligence. Overconfidence during any market environment can be a killer. And figuring out how to take your lesser attributes out of the decision-making process can increase your probability for success.

Those things will never change, regardless of the crisis at hand.

Further Reading:
The Best Books on Financial Market History