Season Investments


A False Sense of Security

Posted on February 28, 2017

“Two points make a line, and then you just extend the line out into the future. That makes for pretty bad forecasting, especially when it comes to economics.” – Jared Dillian

2017-02-28_Security_Guard.jpgThe other day I was reading a blog post from one of my favorite market pundits named Jared Dillian, whose work we have referenced before. In this particular blog post he wrote about pop culture and how movies can be a reflection of the collective fear of any given population projected into the future. For example, Interstellar is a story about the search for new planets for mankind to inhabit due to the fact that blight has taken over earth and ravaged all of the crops and food sources on earth. Although not explicitly stated, it is safe to say that the premise of the movie is a reflection of the current concerns over global warming and the potential catastrophic impact it could have on the earth.

Jared goes on to give several other examples of movies that were set in the future to reflect an extension of the collective fear of a given population, but then points out how few, if any, of these dire state predictions ever materialize because markets are self-correcting by nature.

None of these things ever play out, because economics, politics, and culture are all self-correcting. The cure for high prices is high prices. What happened when oil spent years at $100/barrel? People figured out new places to drill for it. And then we had more oil, and prices came down.

Another way to say the same thing is that human beings are really good at finding creative solutions to our problems and because of this dynamic, it may not be wise to extrapolate today’s problems into the future or as Jared puts it, “two points make a line, and then you just extend the line out into the future.” As we’ve stated multiple times in the past, making linear projections in a complex world that is anything but linear is a fool’s errand at best. Take for example the Y2K scare from the turn of the last century. The theory was that some computer programs would process the turning over of the calendar year as going back to 1900 rather than 2000. Then potential problems were extrapolated to include the end of life as we know it (well almost). An estimated $500 billion was spent globally to prepare for something that ended up being a total non-event.


So why do we as a human race feel the need to make predictions and forecasts about the future? My search to answer this question led me to a very interesting article that was published back in 2015 by the Australian Broadcasting Corporation (also known as ABC by the way) which interviewed several experts and academics to try to answer this exact question. The conclusion they came to is that human beings fear the unknown and making predictions about the future gives us a false sense of security and control over something that is highly unknown.

The future is scary because we don't know what's going to happen, and not knowing intrinsically means we feel powerless, and powerlessness and a lack of control makes any situation scarier. So against that fear, prediction supplies that false sense of control. – David Ropeik, Author & Risk Consultant

In addition to the fear of the unknown, human beings also suffer from hubris rooted in our hindsight bias. We have a tendency to rationalize events after the fact and explain why things happened the way they did by explaining everything through some sort of narrative or story. This process then provides us with a false sense of confidence in our ability to forecast the future as well as we’ve been able to explain the past. Duncan Watts is a researcher, former professor of sociology at Columbia University, and author of the book Everything is Obvious Once you Know the Answer: How Common Sense Fails Us. In the article, he explains why “common sense is misleading” and why it isn’t necessarily healthy to Monday morning quarterback all our decisions.

When I say common sense is misleading, what I really mean is that when we look back in the past, whatever it is that we are looking at, whether it's our own experiences or whether it's the global financial crisis or some foreign policy decision or the performance of a major company, we are always able to tell some story that makes it seem like the thing that happened was in some sense inevitable.

Looking forward we are never quite sure what's going to happen, but when we look back it always seems like we should have known, that the outcome that occurred was really just a matter of common sense. If we had really just been thinking straight we would have known all along that the thing that happened was going to happen.

So this feeling that we have—that common sense had we been using it properly could have told us all the stuff that we missed—is actually very misleading.

The problem with relying on our hindsight biases and creating a false sense of control about the future through predictions is that it has the potential to limit our ability to think creatively and problem solve. The reason Jared Dillian stated that society is “self-correcting” is because human beings continue to think creatively about solutions for today’s problems, but if something, such as fatalistic predictions about the future which everyone buys into, puts an end to that feedback loop, then the prophecy becomes self-fulfilling. In other words, we can be our own worst enemy by holding strong convictions about things that are highly uncertain such as the future. Once again quoting Duncan Watts from the ABC article.

You should never be that certain about your own beliefs—the world just doesn't work that way. You have to be more adaptive, you have to be more reactive. You have to think probabilistically rather than in terms of certainties.

It's not that you are always going to be right, because you are going to make mistakes no matter what, but you might be less inclined to make catastrophically bad mistakes.

In conclusion, we make predictions because of our hubris and hind-sight biases in order to calm our fears about the future by giving us a false sense of control over something that is by nature highly uncertain. The problem in doing so is that it has the potential to short circuit the self-correcting nature of human creativity and ingenuity which enables us to solve problems. Therefore, the solution is to view the future and uncertainty through a spectrum of potential outcomes rather than a single absolute. Just because something has been a certain way for the last X number of years, doesn’t mean that it will continue to be so forever and ever amen.

For us, that means taking a very humble approach to the way we invest by not betting the farm and over exposing the portfolio to any one single risk factor and by implementing a downside protection program in case the future doesn’t look anything like the past. Rather than predicting the future, we spend our time and energy on being adaptive and reactionary to developing trends. And although we make every attempt to get better at our craft and continue to learn from our mistakes, we also realize that there is an inherent danger in judging every decision or mistake we make through the benefit of hindsight if it gives us more hubris about our ability to somehow avoid other mistakes by predicting the future. 

elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.

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