Morgan Housel: What Makes Us Bad Investors?
Clinton State of the Union, 2000
“We begin the new century with over 20 million new jobs; the fastest economic growth in more than 30 years; the lowest unemployment rates in 30 years; the lowest poverty rates in 20 years; the lowest African-American and Hispanic unemployment rates on record; the first back-to-back budget surpluses in 42 years. And next month, America will achieve the longest period of economic growth in our entire history.
We have built a new economy. And our economic revolution has been matched by a revival of the American spirit: crime down by 20%, to its lowest level in 25 years; teen births down seven years in a row; adoptions up by 30%; welfare rolls cut in half to their lowest levels in 30 years.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
My fellow Americans, the state of our union is the strongest it has ever been.”
[Soon after, markets collapsed and the economy suffered its worst decade in 80 years]
Obama State of the Union, 2010
“One in 10 Americans still cannot find work. Many businesses have shuttered. Home values have declined. Small towns and rural communities have been hit especially hard.
And for those who'd already known poverty, life has become that much harder. This recession has also compounded the burdens that America's families have been dealing with for decades -- the burden of working harder and longer for less; of being unable to save enough to retire or help kids with college.”
[Soon after, stocks surged.]
What Makes the Market Tick?
What Makes Stocks Tick?
- 3,000 stocks from 1983-2011
- 39% of stocks were unprofitable
- 19% of stocks lost at least 75%
- 64% of stocks underperformed the index.
- 25% of stocks were responsible for all the market’s gains.
Source: LongBoard Asset Management
We’re Not Very Good at What We Do…
- In 2011, 84% of actively managed U.S. stock funds underperformed their benchmark. –S&P
And It’s Nothing New …
- Vanguard Group: “The percentage of funds that underperformed the market was 62% for the 10- year period, 67% for the 15-year period, and 72% for the 20-year period.”
- "The 50 stocks in the S&P 500 with the lowest analyst ratings at the end of 2011 posted an average return of 23 percent [in 2012], outperforming the index by 7 percentage points." – Bloomberg.
Worst, we are oblivious.
- Franklin Templeton asked 1,000 investors if the S&P 500 went up or down last year.
- 2009: Stocks rose 26.5%. 66% of investors thought market declined.
- 2010: Stocks rose 15.1%. 48% of investors thought market declined.
- 2011: Stocks rose 2%. 53% of investors thought market declined.
Not as good as you think …
- Markus Glaser and Martin Weber, University of Mannheim.
- Surveyed investors, then checked brokerage statements.
- Lake Wobegon: Most considered themselves above average.
- On average, investors overestimated their annual returns by 11.6% each year.
- Those with lower actual returns were the worst at judging their returns.
- “The correlation between self ratings and actual performance is not distinguishable from zero.”
So, what happened?
- Standard response is that we’ve been through an unprecedented period, or the market has changed, or Wall Street has cheated you, or some other level of blame.
- Reality is that very little has changed. Markets have been working like this for centuries.
S&P 500 has been one of the greatest generators of wealth ever known
- $1 invested in 1900 was worth $1,016 by 2013 (annual return of 6.3%).
- $1 in Treasuries was worth $6.36
- $1 in gold worth $1.92.
- $1 in cash worth $0.07.
S&P 500 total real return distribution 1871-2011
Buy high, sell low!
- 2007: $85 billion put into stock mutual funds.
- 2008-2009: $230 billion pulled out of stock funds.
- 2013: $68 billion put into stock mutual funds. Source: ICI
The Three Terrors of Investing
- Trying to predict things.
- Not having enough time.
- Cognitive biases.
“It is difficult to make predictions, especially about the future." -- Yogi Berra
Economist Alfred Cowles dug through forecasts of William Hamilton, a popular analyst who "had gained a reputation for successful forecasting" made in The Wall Street Journal in the early 1900s.
Among 90 predictions made over a 30-year period, exactly 45 were right and 45 were wrong.
Examples are everywhere
- 2003-2007, Standard & Poor’s predicted 0.12% of a certain type of mortgage bond would default.
- In reality, 28% did.
- In 2008, Gazprom CEO predicted oil would soon hit $250 a barrel.
- It soon hit $33 a barrel.
- In 2008, analysts predict the S&P 500 will earn $94.
- It earned $15.
- In 2010, analysts predict the S&P 500 will earn $53.
- It earned $83.
“Analysts are terribly good at telling us what has just happened but of little use in telling us what is going to happen in the future.”
It takes skill to be this bad …
- Ron Alquist and Lutz Kilian, 2007.
- Looked at analyst projections of future oil prices, futures prices, econometric models, company projections.
- Best predictor of future oil prices is to assume it will be whatever today’s price is.
- Does it work? Not even close. But it’s better than most forecasts.
See full slides below.