An Idle Thought
An Idle Thought - Inspired by Malcolm Gladwell
After falling 34%, U.S. stock markets continue to climb higher despite historically horrible economic data. Amazingly, the S&P 500 is slightly positive on a YOY basis, although it is still down 11% YTD. It's truly terrifying to look at the record unemployment numbers and projected drop in earnings growth we are experiencing since the invasion of COVID-19.
The reason the stock market is bouncing back is that it is a leading indicator, not a lagging indicator. Investors don't care about yesterday, they care about tomorrow. Investors buy and sell based on their expectations of future growth. Despite these terrible economic numbers, the stock market appears to be saying it expects the economy will be able to recover from this pandemic. Of course, when and by how much is the million-dollar, actually trillion-dollar, question. Admittedly, we are a bit out of our comfort zone in this current environment. At the broadest level, there are two styles of investment managers, quantitative and qualitative. Our investment process is heavily oriented towards the former. We prefer a quantitative investment process that is designed to remove emotion and subjective forecasting. We emphasize investing based on the historical relationships between asset classes and observable economic data. Our belief is this type of structured investment process helps to avoid the pitfalls that qualitative investing all too often brings. Primary among those pitfalls are that investors are overconfident in their ability to forecast the outcome of macro events, such as pandemics and geopolitical issues, and qualitative investors often let their emotion overrule their logic. Our CWB is a reminder that many dire forecasts turn out not to be not as bad as originally feared.
The current challenge for "quants" like us is that current economic numbers are somewhat unusable. The unemployment rate shot up from 3.7% to 14.7% last week. Economic forecasts for future growth and unemployment are all over the map. Does that mean we are all now qualitative managers? Not exactly. Our portfolios still use longer-term market averages to properly construct portfolios that match an investor's return needs with their risk profile. Our challenge is with shorter-term tactical moves. Our tactical process uses economic data to overweight undervalued asset classes and underweight overvalued asset classes. While this has treated our investors well, we readily admit current economic data is not very useful for short-term forecasting. Our last commentary was titled, "The Black Swan". The main theme of the commentary was that events such as pandemics, and their aftermath, are not predictable. Therefore, we decided rather than try to predict a post-coronavirus world, we would simply muse. (See how we did that?) We mused; if stock markets continue to shoot higher maybe this is how investors will explain, with hindsight bias, the obvious reason for this black swan event; when the government put record amounts of stimulus into an economy that was only temporarily impacted, but structurally sound, when the temporary obstruction was removed, of course, the economy was greatly overstimulated. Our simplistic, and we thought the obvious, conclusion was that in the near-term stock markets would move inversely to the pandemic. We are quickly realizing that our conclusion is not universally shared. Much of the national conversation on cable news as well as articles in popular publications argue that regardless of when the pandemic eases, consumers will not consume again anytime soon. Many sociologists and mental health experts tell us consumers will be too scared to return to restaurants and shops, as well as other crowded venues. This is indeed concerning, we are a consumer-driven economy that relies on humans interacting with one another. The alarm is also being sounded about the potential social fallout our nation will experience as a result of our experiences with isolation and self-distancing. Some sociologists are predicting large increases in mental diseases like depression and anxiety. Thought leaders warn of spikes in domestic abuse and alcoholism. They may be right. They also may be wrong. Predictions about this crisis, as well as previous crises, are often proven inaccurate in hindsight. We certainly hope the sociologists are wrong this time. Listening and reading predictions about the post-COVID-19 world reminded us of a story from Malcolm Gladwell's David and Goliath about the German bombing of London during World War II. We've stated many times we are not virologists, and therefore we will not try to outguess the experts. We will add to that we are also not sociologists or psychologists. Our mathematical backgrounds aren't designed to forecast human behavior, they are however designed to recognize the inaccuracies of forecasting. We found these excerpts from Gladwell's book to be both interesting and inspiring; Winston Churchill described London as ‘the greatest target in the world. . . . He predicted that the city would be so helpless in the face of attack that between three and four million Londoners would flee to the countryside. In 1937, on the eve of the war, the British . . . issued a report with the direst prediction of all: a sustained German bombing attack would leave six hundred thousand dead and 1.2 million wounded and create mass panic in the streets. People would refuse to go to work. Industrial production would grind to a halt. The army would be useless against the Germans because it would be preoccupied with keeping order among the millions of panicked civilians. The country’s planners briefly considered building a massive network of underground bomb shelters across London, but they abandoned the plan out of a fear that if they did, the people who took refuge there would never come out. They set up several psychiatric hospitals just outside the city limits to handle what they expected would be a flood of psychological casualties. ‘There is every chance,’ the report stated, ‘that this could cost us the war.’ In the fall of 1940, the long-anticipated attack began. The Germans relentlessly bombed London on a nightly basis for 8 months. 40,000 people were killed, 46,000 were injured, and more than one million buildings were damaged or destroyed.
It was everything the British government officials had feared—except that every one of their predictions about how Londoners would react turned out to be wrong.
The panic never came. The psychiatric hospitals built on the outskirts of London were switched over to military use because no one showed up. Many women and children were evacuated to the countryside as the bombing started. But people who needed to stay in the city by and large stayed. As the Blitz continued . . . the British authorities began to observe—to their astonishment—not just courage in the face of the bombing but something closer to indifference. ‘In October 1940 I had occasion to drive through South-East London just after a series of attacks on that district,’ one English psychiatrist wrote just after the war ended:
‘Every hundred yards or so, it seemed, there was a bomb crater or wreckage of what had once been a house or shop. The siren blew its warning and I looked to see what would happen. A nun seized the hand of a child she was escorting and hurried on. She and I seemed to be the only ones who had heard the warning. Small boys continued to play all over the pavements, shoppers went on haggling, a policeman directed traffic in majestic boredom and the bicyclists defied death and the traffic laws. No one, so far as I could see, even looked into the sky.’
I think you’ll agree this is hard to believe. The Blitz was war. The exploding bombs sent deadly shrapnel flying in every direction. The incendiaries left a different neighborhood in flames every night. More than a million people lost their homes. Thousands crammed into makeshift shelters in subway stations every night. Outside, between the thunder of planes overhead, the thud of explosions, the rattle of anti-aircraft guns, and the endless wails of ambulances, fire engines, and warning sirens, the noise was unrelenting.
The typical explanation for the reaction of Londoners is the British “stiff upper lip”—the stoicism said to be inherent in the English character. (Not surprisingly, this is the explanation most favored by the British themselves.) But one of the things that soon became clear was that it wasn’t just the British who behaved this way. Civilians from other countries also turned out to be unexpectedly resilient in the face of bombing. Bombing, it became clear, didn’t have the effect that everyone had thought it would have. It wasn’t until the end of the war that the puzzle was solved by the Canadian psychiatrist J. T. MacCurdy, in a book called The Structure of Morale.
J. T. MacCurdy divided the Londoners into three groups in his study: the first were considered direct hits, those that were killed; the second he termed near misses, those that were traumatized by the bombing, maybe having their house destroyed or someone they knew killed.
Third, he said, are the remote misses. These are the people who listen to the sirens, watch the enemy bombers overhead, and hear the thunder of the exploding bombs. But the bomb hits down the street or the next block over. And for them, the consequences of a bombing attack are exactly the opposite of the near-miss group. They survived, and the second or third time that happens, the emotion associated with the attack, MacCurdy wrote, ‘is a feeling of excitement with a flavour of invulnerability.’ A near miss leaves you traumatized. A remote miss makes you think you are invincible.
MacCurdy's observation was that the vast majority of Londoners (more than 99%) fell into the remote misses category. Rather than being traumatized, they lost their sense of fear. If current trends hold up, more than 99% of us will be considered remote misses in our society's battle with COVID-19
‘We are all not merely liable to fear,’ MacCurdy went on. ‘We are also prone to be afraid of being afraid, and the conquering of fear produces exhilaration. . . . When we have been afraid that we may panic in an air-raid, and, when it has happened, we have exhibited to others nothing but a calm exterior and we are now safe, the contrast between the previous apprehension and the present relief and feeling of security promotes a self-confidence that is the very father and mother of courage. This is just an idle thought we found interesting while in lockdown. You can take it or leave it. We are not predicting that the concerns of sociologists, and many others, will be less dire than feared. However, that is a realistic possibility.
Book Review David and Goliath - It's likely many of you have already read this book by Malcolm Gladwell. It was released in 2013. Gladwell could be accused of massaging numbers and stories to make them fit his hypothesis, but he provokes thought and challenges conventional wisdom. We like that. Today is tomorrow, which we worried about yesterday, The GreenPort Team