Against Cassandras

So many investors love to listen to market gurus who forecast impending doom. At the moment, it seems it is another high tide for doom and gloom and, depending on the day, we can read articles about why we are going to enter a decade of high inflation like the 1970s, suffer from an exploding debt bomb that will ruin most of the developed world, see our social security system and pension funds collapse under the weight of a demographic catastrophe, enter another financial crisis because banks go bankrupt, or get to the brink of World War III because China invades Taiwan or Putin uses nuclear weapons. Oh, and did I mention that the US dollar is going to collapse? Today, I start a series of posts that will call out the bs in these kinds of ‘forecasts’.

John Stuart Mill once wrote: “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.” This is, in my opinion, the main reason why there are so many independent forecasters who peddle doom and gloom. And did you notice that it is always ‘independent’ people who make these forecasts?

If you are no longer employed by a major bank or investment firm, you may find yourself with a rolodex of former clients you can call up to ask for money, but in order to get their attention, you have to deliver something they don’t get from a major firm. And the best way to get attention is to make outrageous forecasts of impending catastrophe. That will trigger loss aversion in your audience, and they will pay close attention to your advice because you are the one who knows what the establishment doesn’t. Or you claim that the big firms cannot talk about these things openly because their business interests are such that they always have to be bullish. So, investors have to listen to you as the one who can speak the truth. And you know that things will go terribly wrong if people don’t pay attention to you and pay loads of money to get access to your wisdom (ok, the last bit is normally not mentioned explicitly by these ‘independent’ forecasters).

It doesn’t matter if you have no data to support your view, you can always populate some charts with remotely relevant economic data and then claim that as this line goes down, the economy will follow, and markets will tank.

Over the next few Wednesdays, I will take you with me on my little summer project, discussing some of my favourite doom-and-gloom predictions and why I think they are very unlikely to materialise, if not impossible. Sometimes I may even be able to show you what happens to your investments should you follow the advice of those doom-and-gloom prophets.

In short, over the next couple of weeks, I will become shamelessly optimistic and give you all the reasons why it is unreasonable to be pessimistic. Call it a good news summer if you like.

Of course, when I attack those negative forecasts, it doesn’t mean they cannot come true. If I am really unlucky, one of the doom-and-gloom scenarios may even come true while I am publishing this series of posts. But just because bad things sometimes happen doesn’t mean that betting on bad things to happen is a good idea. Or, to quote another great man, Seneca, “There are more things to alarm us than to harm us, and we suffer more often in apprehension than reality.”

Take a look at the US and UK equity markets since 1900 in the chart below. I have plotted them in logarithmic scale so that drops of equal percentage are shown in equal size. I have also marked the biggest drops of the last 123 years in the chart. Note that the only doom-and-gloom events that actually materialised were the Great Depression, World War II, and the Global Financial Crisis of 2008. That is three major events that happened and had a significant negative impact in 123 years, or roughly once every 40 years.

US and UK equity markets since 1900

Source: Liberum

There were additional events that had a significant negative impact, like the tech bubble burst in 2000, but that was not a doom-and-gloom event like the ones predicted by market gurus. Rather, it was an event widely anticipated by a large group of market strategists and investors. Then there were other events like the 1970s oil crisis and period of runaway inflation that I would classify as a doom-and-gloom event, but as far as I know, nobody has ever claimed to be the one who saw all that coming.

Oh, and then there are tons of doom-and-gloom events that occurred but were completely forgettable in terms of markets. You may be able to identify the global pandemic of 2020 in the chart, though you have to squint your eyes. Now how about the Cuban Missile Crisis of 1961, where we were extremely close to World War III? How about the Cold War in general? Or the Vietnam War? Or the Iraq and Afghanistan Wars? Or 9/11 and the threat of global terrorism? How about World War I or the pandemic of 1918? How about any of the government defaults of the 20^th century, like the Asian crisis in 1997 or the Russian default of 1998? What about the banking crises of the late 1980s in the US when thousands of banks went bankrupt? Or the end of the Bretton Woods system for currencies when the US dollar was taken off the gold standard and became a true fiat currency?

One of the most important rules of forecasting is rule number five of my ten rules of forecasting:

“We rarely fall off a cliff. People often change their habits at the last minute before a catastrophe happens, but for behavioural change to happen the catastrophe must be salient, the outcome must be certain, and the solution must be simple.”

As I will likely point out many times over the coming weeks, this is the rule that people who make doom-and-gloom forecasts and the people who listen to them constantly forget. Or, as one of my mentors once put it: “What cannot happen, will not happen.”