As humans we seek a measure of control over our financial futures. One way we do this is through stories. Since the Great Recession of 2008 the abiding narrative about the economy is that, eventually, business conditions will return to “normal”. This is the story we have wanted to hear. This week we examine problems with that narrative, assumptions behind it, and consequences for investment policy.
Is there such thing as a normal economy? We tend to think of the economy as a system moving in big cycles, and there is a reversion to some long-term trend. What if this sort of thinking is little more than a form of bias based on recent experience? What if the economy has no tendency to revert to past growth rates and instead moves in a series of fluctuations that depend more upon future, rather than past, developments. If that’s true, then there is no “normal.” There are only a series of “new normals” that are always developing inside of the economy as it evolves over time, according to a piece that appeared on MarketWatch.
Trends are not destiny. Relying on the long run for investment decisions is essentially relying on trend lines, according to the late Peter Bernstein, writing for The Financial Times in 2009. The long-run results we discern in stock market data have a specific historical context. The next period’s results can turn out differently because conditions will be different. The next period’s results are not predestined. We really do not know what will happen. (Tiered Registration Required)
In the face of uncertainty what matters is the quality of the decisions we make. Trends are not destiny. We can never know what will happen. Therefore, risk would not exist if we could correctly anticipate the future. In the face of uncertainty, how we think about risk matters, according to the late Peter Bernstein, in this CFA Institute presentation. Managing risk in investment portfolios is about quality decision-making when conditions are uncertain. Treat uncertainty as a friend, with care, consideration, and attention to consequences.
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J. Mark Nickell & Co.
Disclosure – The articles mentioned in This Week with J. Mark Nickell & Co. are for information and educational purposes only. They represent a sample of the numerous articles that the firm reads each week to stay current on financial and economic topics. The articles are linked to websites separate from the J. Mark Nickell & Co. website. The opinions expressed in these articles are the opinions of the author and not J. Mark Nickell & Co. This is not an offer to buy or sell any security. J. Mark Nickell & Co. is under no obligation to update any of the information in these articles. We cannot attest to the accuracy of the data in the articles.