TedCo Software Financial Matters Blog

The Bias sisters can really mess with your head. If you are judging your own performance or that of an advisor these two odd behaviors can prevent you from pursuing a sound investment strategy. The Bias sisters, outcome and hindsight, are quite vain and spend most of their time looking in a mirror (a rearview mirror).

Outcome Bias
In a 1988 study Jonathan Baron and John Hershey presented participants descriptions of several different medical situations facing a doctor. The descriptions included what the doctor knew, the treatment provided, and the outcome. However, in some instances the outcome was described as a success, while in others it was deemed a failure. All the other factors (available data, treatment, etc.) were identical. Here is where the bias appears; by a factor of around 5 to 1 the successful outcome was rated as representing higher quality decision-making. This result appeared despite the fact that 88% of the participants agreed that the outcome shouldn’t be included as a factor in rating the quality of the decision. When combined with the tendency to give more weight to the most recent events (myopia) this has many investors beating themselves (or their advisors) up when the market turns against them. Even a really well considered decision can go bad, so take a deep breath and stick to the plan. Even House, M.D. loses one once in a while. Particularly if the loss was related to a macro event (market drops, housing slows, and the like) then hindsight bias comes along and beats on you some more.

Hindsight Bias
Whenever the equity markets (stocks) have a big move the market “experts” appear within minutes of the close to explain what happened. These pundits always explain events with great confidence. The impression you walk away with is that any dope should have known that was going to happen if they just paid attention. Where were all these experts before the market went south? They didn’t know either, they are just good talkers. Markets experts humbly admitting their surprise doesn’t make for good television/radio/print/internet/pod-vidcast ratings. This is where experience can help. I remember a market newsletter writer that predicted the 1987 crash. She translated that success into huge circulation for her newsletter. It would have been more impressive if she had not also predicted the crash of 1984, and 1985, and 1986. If you do not remember the crashes in 84, 85, & 86 that’s because there weren’t any.

We can see this in the news this week. There is a lot of “buzz” about the Hindenburg Omen. This technical indicator has triggered before every major market drop for years. That sounds good. However, the omen has triggered four times for every drop. Its’ accuracy is only 25%. Interesting, but not a reason to buy ammunition and hide under the bed.

Don’t let hindsight and outcome bias beat you up. The markets are by nature unpredictable and no approach works every time in all situations. Stick to your plan. There is nothing wrong with adjustments, but if the plan was sound to start with, it will likely work out just fine.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

On the bright side: oil prices are still low. Other than that there is not a great deal to be happy about in the equity markets. My last “hedge now” signal lit up last week, so expect some rough travel ahead.

So what is going on? The market is reacting to a number of issues. As I mentioned in an earlier post the market has been looking for an excuse to drop back some, and the world has given it plenty of excuses.

The latest bugbear is the Hungarian debt crises. Fears of contagion and an unraveling of Eastern Europe dropped the Euro to new recent lows. (As a note, this last drop puts the Euro back into the middle of its long term average.) If Hungary goes under it will be, well, mildly disturbing. While the world watches Hungary the real danger continues to reside elsewhere, particularly Spain. If the real estate bubble pops there soon then Europe is in a world of hurt and it will impact us here in the US. The RE bubble in Spain is going to collapse; the question is one of timing.

The US jobs report was disappointing. There was little private sector hiring. Most of the big number of reported new jobs were census jobs. The jobless rate dropped largely because many of those who had become encouraged and re-entered the job market were disappointed and promptly exited (though the real rate of unemployment did drop a very small amount). Weekly hours are up, as are temp workers; all good signs. The pattern of recent (1991-92 & 2001-02) recessions has been little job growth until well into the recovery. The history of big job growth early in a recovery is mostly a post-WWII phenomenon. The sad reality is that a jobless recovery is the historical pattern reasserting itself. Why did this report upset the markets so much? First, the market is looking for excuses to drop. Second, people have little sense of history.

We are still in a recovery and a double-dip still appears unlikely. This recovery, however, could be the weakest in a long time (I’m still hoping for better).

Be glad if you are not in Europe.

Jim Heitman, CFP®, is a writer, speaker, Certified Financial Planning practitioner in Southern California, and the founder of Compass Financial Planning – a fee-only planning and money management firm.

European debt issues are dominating the headlines, and those problems are serious, but the Europeans are not the only ones swimming in the debt pool. Excessive debt is a global reality and most of the developed nations are playing the game hard. Really very few nations operate in the black, mostly oil producers. Many emerging economies have kept control of the debt load. It isn’t that it can’t be done by developed nations; Norway operates in the black, and Canada and Australia carry very reasonable debt loads. China carries little debt, and has huge reserves (however, they have significant infrastructure issues that will need to be addressed in the next decade).

So who’s overspending? Greece, obviously, and all the bailouts are likely to accomplish is to ease the sting of an eventual default. Spain, Portugal, Ireland, and Italy are in some trouble, and Germany, France, the UK, and Japan are spending way too much. Japan and the UK control their own currency so expect efforts to devalue. The Euro is already at a four year low and likely to continue to drop versus the dollar.

What about the US? We are in slightly better shape than our G7 partners (or is it G8 now?). Our debt load is somewhat lower than others (as a percent of GDP), but out deficit spending (as a percent of GDP) is near the top and presents a real danger.

Over the long run the problem must be resolved with a mix of higher taxes and less government spending. That will have a depressive effect on the economy. If the same effect happens to many economies world wide then you can expect slow going for the world economy. That means slower job growth and smaller fixed returns on investments. The sad truth about debt is that somebody always pays. When the debt is your country’s then that somebody is probably you.

One of the sad things here is that a politician who says that we have to radically reduce spending to pay off the debt is probably not getting elected. Nobody likes the sad-sack downer guy, even when he is right.

Jim Heitman, CFP®, is a writer, speaker, and Certified Financial Planning practitioner in Southern California.

(Editor’s note: Jim’s “Mid-Year Planning” series will continue next week.  Today’s post was published today due to it’s timeliness.)

I have started this post three times, and each time found it outdated by the time I completed it. The tragic loss of life in the Athenian riots was particularly troubling.

Why is this happening, what does it mean, and what could it mean to me and you?

The toughest part of writing about an event like this is that there is little in the way of historical precedent to use as a guide. The markets hate uncertainty more than they hate bad news. That’s why you see such dramatic moves in the markets; nobody really knows what will happen next.

Greece is in trouble. The government of Greece is much more involved in the day-to-day financing of their citizen’s lifestyle than you see here in the states. Unfortunately, the government has been borrowing to make these expenditures for some time now and they simply can’t make the payments on the debt anymore. The government cutting back on these services while raising taxes sounds painful to most normal folks. In the old days a nation facing this problem would just print more money to pay back the loans. Sure, it would lead to hyper-inflation within the country, but that would resolve without hurting too much (except for the citizens of that country). Greece can’t do that. When they joined the European Union they gave up the option to devalue their own currency. Some sort of default is in the cards.

So what sort of “bad stuff” could happen? If the IMF and the other EU nations step up for a bailout they will postpone the eventual default, maybe long enough for austerity measures to begin to turn the situation around. If it happens sooner it will likely spread to other nations in similar but less severe situations (Spain & Portugal, in particular).

The best case scenario is that the problems are contained within Greece, who will suffer through a multi-year depression.

How will this impact you and me? A depression in Greece will have very little impact, and our economy will keep percolating along. A depression in Greece, Spain, Portugal, Italy, and Ireland, along with recessions in Germany, France, Japan, and the UK, would tip us into a recession. That would be unpleasant, but survivable. On the plus side, the drop in demand for oil combined with the increased demand for the dollar that would accompany the end of the Euro will likely push gas prices down dramatically. See, there’s always an upside. It will be cheaper to drive to the job you won’t have.

Nobody really knows what the result of this debacle will be. The one truth is that “This too shall pass.” Soon enough the world will find something else to panic about. Just stick to the basics and hold on.

Jim Heitman, CFP®, is a writer, speaker, and Certified Financial Planning practitioner in Southern California.