Quote for the Week

Hindsight occurs when a surprising event takes place and the surprise is very brief, replaced almost immediately by a need to make sense of it. The individual has learned something from the event. For example, if there were two football teams that you considered equally-matched, and one of them trumps the other 5-0, they are no longer equally strong in your mind. One of them is clearly better than the other. This makes sense of their victory. It also makes it virtually impossible for you to re-construct that, earlier, you thought they were equal.

Now, we think that the team that actually won “had to win.” Why did it have to win? Because it won. It won because it was stronger. How do we know it is stronger? Because it won. This is hindsight. It has a huge effect on our thinking, it has a huge effect on investing behaviour, and it has a very pernicious effect, in that it teaches us something quite wrong about the nature of reality…

Now, an example of that, of course, is the Great Recession. There are many people who predicted the Great Recession – there are many more now than there were then. The film The Big Short was based on a book, written by Michael Lewis. The book really invites you to hindsight. There are a few people – they are obviously very clever people, and they knew that the market was going to crash. And you can’t help but get the feeling that the people who didn’t know the market was going to crash were either fools or knaves. Intelligent people saw the recession coming. But in fact, and that is a well-known fact, many highly intelligent and well-informed people did not anticipate the crash. The conclusion is that the crash was not quite as predictable as it now appears. It now appears highly predictable, in hindsight.

So, the pernicious effect of hindsight is that we get the sense, after the fact, that an event was predictable, so we get the sense that the world is predictable. We think the world makes sense, and that exaggeration of the coherence, consistency and predictability of the world means that we deny the real uncertainty with which we are faced in existence. And this denial of uncertainty in turn produces irrational action. — Daniel Kahneman (source)

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Here’s what I’ve been reading for the past three months:

• Invention and Innovation: A Brief History of Hype and Failure — Vaclav Smil digs through the history of invention to focus on the failures — the innovations that started out promising but ended disastrously, that were the next big thing but fell far short of the hype, or have been overhyped for decades but are still more science fiction than reality — and the lessons that can be learned from it. (notes)
• To Engineer is Human: The Role of Failure in Successful Design — Engineering design, going back to building the pyramids, has been a process of learning from repeated failed designs that lead to improvement and success. The similarities between engineering and investing come through in the reading. Notes to come.
• How to Avoid Losses in Your Investing — Written in 1920, this short book covers all the ways you can lose money — speculating, gambling, margin, the wrong broker, and more. You can lose money the same way today. It’s a reminder of how little has changed with investing in over a century.
• Poor Charlie’s Almanack — I read a prior edition of Poor Charlie’s Almanack years ago. The new edition is an excuse to slow read the book again again. A free version can be found here.

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Quote for the Week

One of the major differences between behavioural economics and standard economics, is that, in standard economics, the individual agent is supposed to be driven or motivated by the utility of future wealth and discounted future wealth and present wealth. In behavioural economics, agents are supposed to be motivated by something else: gains and losses.

This juxtaposition of gains and losses on the one side and wealth on the other is interesting. Gains and losses are temporary — they are events. Wealth, on the other hand, is a state. It is a broader way of looking at things. In fact, what dominates our behaviour is much more immediate than considerations of wealth. It is consideration of gains and losses. That is the essential idea of both behavioural economics and behavioural finance. A fully rational agent has a broad view – it has a long horizon. But a basic finding, well replicated in psychology and decision theory, is that people are myopic and that they weigh immediate consequences much more than delayed. There is in fact brain research that indicates that there are special brain circuits that respond to relatively immediate consequences, and other brain circuits that react to more delayed consequences, and we tend to be more rationale about the more delayed consequences than about the immediate consequences. — Daniel Kahneman (Source)

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Quote for the Week

In all my 55 years on Wall Street, before I retired to do something vastly more important, I was never able to say when the market would go up or down. Nor was I able to find anybody on Earth whose opinion I would value on the subject of when it would go up and down. But lastly, I never needed to know that. All I did was to search all over the world for where were there some shares selling for a remarkably low price in relation to the potential future earnings. — John Templeton (source)

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