The older I get the more skeptical I become regarding financial forecasts. Most are clothed in sweet sounding statistics to sexify the pitch, make it more palatable for the little people to stomach. Unfortunately, data can be tortured until it tells you anything you want it to. Perhaps no one said it better than Mark Twain:
“There are three kinds of lies: lies, d*mned lies, and statistics.” (edited for the children)
Look no further than our current market for example. As we survey the past to see where the market has come from, where do most people’s eyes gravitate towards? I betcha it’s the March 2009 low, the infamous devil’s bottom.
Because it’s easy to spot, marks the termination of the last big bear market, and the genesis of the current bull market. And if that’s your starting point you can spin a pretty terrifying tale like: Oh Em Gee, the S&P 500’s ascension is going on its seventh year without a significant bear market. We’re so overdue for a crash. You’d have to be a nincompoop to buy stocks up here. What are you mad?
When you anchor on 2009 the market looks seriously lofty here. And with the great stock stall of 2015 the future looks ominous!
See, it’s easy to scare the children with the right starting point.
And yet, were I a money manager trying to get you to throw some more dough my way so I could increase my assets under management (not to mention my pay), I could switch out the lens you’re using to view stocks by switching the time frame. I came across a superb example of this the other day while sifting through my blog feed. Check out this trio of charts shared at The Reformed Broker:
The first shows how the past five years of returns for the S&P 500 was better than 66% of all other 5-year periods. Which is one way of emphasizing how strong the current bull market has been relative to past ones. If you’re a mean reversion fanatic this stat would support a more pessimistic view of the market since we’ve had it so good for so long.
And yet, if we change our perspective to the 10-year view, things don’t look so overheated. The 10-year compounded return is only 7.5% for the S&P 500 right now which is “lower than 70% of all periods.” Veterans would say the last decade has been somewhat blah. If past is prologue then better returns on the horizon. But wait, there’s more.
If you really want to giddy up the masses show them the following chart of 15-year total returns. By the way, “total returns” takes into account price appreciation plus dividends. The compounded return for the S&P 500 over the past 15 years (since 2000, basically) is a lousy 5.1%. And that’s even after the massive run we’ve seen these past few years. So how does the last 15-years rank among all 15 year periods? Lousy, lousy, and lousy. It’s lower than 88% of all periods. Shoot, through that lens, you have to be optimistic about the future returns. See, that’s the thing with mean reversion. Below average returns are virtually always followed by above average returns.
But here’s the rub. You must mind your time frame. 15-year total return averages shouldn’t really register to a short-term trader. It’s completely irrelevant. And yet, if you’re socking away money for retirement that you don’t want to actively manage, well, then the last chart should really warm you up to putting money to work here.
Switching out the lens by which we count market returns is an interesting example of anchoring. This per Wikipedia:
“Anchoring … is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. During decision making, anchoring occurs when individuals use an initial piece of information to make subsequent judgments. Once an anchor is set, other judgments are made by adjusting away from that anchor, and there is a bias toward interpreting other information around the anchor.”
When forming expectations for future market returns, be aware of how anchoring can skew things. Sure, you have to begin to count market returns somewhere, but make sure you don’t make any certain starting point the end all-be all anchor. Just because the 2009 low carries heavy psychological significance doesn’t mean we have to measure all future returns against that level.
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