The Irrational Pessimist

Scan the headlines of media anywhere in the world and you always will see disaster looming on the horizon.

The world, it seems, is always on the verge of coming to an end. I remember my second-grade classroom had dozens of copies of Stanford professor Paul Ehrlich’s “Population Bomb,” which predicted that hundreds of millions of people would starve to death in the 1970s and 1980s. Think of all the apocalyptic predictions just over the last decade — AIDS, Y2K and the SARS virus. I remember reading a headline in London in 2003 about a study that predicted that 50,000 people would die from “mad cow disease” in the United Kingdom alone. That’s the same number of Americans who died in the Vietnam War. Two years ago, physicist Stephen Hawking wanted to hold an “end-of-the-world” party upon the launch of the European Large Hadron collider, which some physicists had predicted “could destroy the Universe.” But Hawking wisely held off, assuming the media would misinterpret his tongue-in-cheek exercise. Last Saturday, I spent one of my most pointless two hours in recent memory watching “2012,” a movie that celebrated the Mayans’ prediction of the end of the world in that same year.

History is littered with experts — and leaders of cults — who predicted the end of the world and got it wrong. The philosopher Bertrand Russell predicted in April 1961 that if the great powers did not change their policies, “it is in the highest degree improbable that any of you here present will be alive 10 years hence.” At that same forum, Russell also quoted an article by an overconfident, albeit gloomy, C.P. Snow, who noted that: “Within at the most 10 years, some of these bombs are going off. I am saying this as responsibly as I can. That is a certainty.” (If you want an antidote to the relentless pessimism of today’s 24/7 media, take a look at science writer Matt Ridley’s recent book: “The Rational Optimist.” You also can view his recent presentation at the Oxford TED conference.)

The Irrational Pessimist: Why Do Experts Get It So Wrong?

The Greeks turned to Oracles to predict the future. In Roman times, soothsayers read animal entrails. These days, the experts we turn to are Nobel Prize-winning economists and academics. While we may smile at the Greeks and Romans, the irony is that thinking too much — about, say, “scientific” financial engineering — only gives you more misplaced self-confidence to screw up and to do so in a much bigger way. The grandest hedge funds in the world invested with Bernie Madoff, their psychological denial trumping ostensibly sophisticated financial understanding.

So why are we so bad at prediction, even as we are psychologically addicted to it? The world is a complex place. Psychological studies have shown that few things can drive you nuts faster than the feeling that you’ve lost control. That’s why we also tend to seek patterns where no such patterns exist (like technical analysis), as well as to confirm our pre-existing beliefs (what psychologists call “confirmation bias.”) We gain psychological solace from an explanation — whether it has any basis in truth or not.

It takes exceptional self-confidence to argue against ideas that both made people rich and won their progenitors a fistful of Nobel Prizes. Even in the face of overwhelming evidence, like the disgrace of “modern finance” in 2008, we’d rather cling to widely accepted explanations even when experience suggests they are wrong. And this tendency applies to supposedly “objective” areas like science. It took the Roman Catholic Church until October 31, 1992, to concede that the Earth was not stationary as Galileo had argued in 1633. You can only hope that today’s business school textbooks espousing modern finance will move more quickly.

The Irrational Pessimist: Astrological Armageddon Ahead

The elephant in the room is that the predictive capabilities of modern finance are no better than, say, astrology. And you gotta admit, astrology is a heckuva lot more entertaining.

Consider the case of the top-performing financial newsletter of 2008, Arch Crawford’s Crawford Perspectives, which gained 42.4% through the end of 2008. Crawford’s winning strategy? Technical analysis leavened by a liberal dose of astrology. Yes, chart reading and star-gazing beat Nobel Prize-winning modern financial theory during the financial meltdown. After a rip-roaring 2008, Crawford was cheerfully optimistic about the stock market in 2009, predicting a much stronger and more lasting advance. He was right again. No wonder Hulbert Financial Digest ranked Crawford the #1 Stock Market Timer for the period October 1, 2007, through October 31, 2009.

So what does this modern-day Oracle say about today? Sadly, Crawford’s current thinking sounds like a trailer to another disaster movie. The Mars/Uranus Crash Cycle is now active. In fact, “we are now in the midst of the most powerful planetary alignment in all of human history July 30 to August 3 with echoes August 8-10 and larger ones on September 21-22 and December 21-22.” And, even worse, this will  continue for the period August 1, 2010, through March 2011.

Crawford’s conclusion? “During 2010, expect as great or greater Crash than has yet ever been experienced!” Crawford recommends “proper emergency measures such as extra food, water, medicines and cash over the next 24 months in particular. Do not wait any longer!!”

Although the Nobel Prize committee or the faculty of University of Chicago or Wharton Business School will never take Crawford’s astrology with anything more than a pinch of salt, the irony is that the philosophy they do take seriously — modern finance — hardly can boast a better track record throughout the toughest period in recent financial history.

The Irrational Pessimist: What Is To Be Done?

So what lessons are there in this for how you manage your portfolio? Top traders (and not just lucky ones) know that during times of uncertainty, it’s best to pull in your horns and bet selectively on a handful of ideas until the dust settles. As George Soros pointed out, thousands of hedge funds forgot the #1 rule of hedge-fund investing: “Don’t lose money.” While that advice turned Soros into a billionaire, it’s too simple to win him a Nobel Prize or, since he does not edit a newsletter, a high-ranking in the Hulbert Financial Digest. But Soros’ insight does show that common sense and level headedness trumps complex predictions yet again — and in an unexpected way, stands closer to financial astrologer Crawford’s advice than that of Nobel Prize-winning propeller heads.

And, if you ever find yourself caught in the grips of “irrational pessimism,” remind yourself of this bit of sage advice: “Don’t worry about the world ending today. It’s already tomorrow in Australia.”

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