I'm Sure

October 17, 2020

“You’d better be right or don’t bother coming in.” Those were about half the words, and the only repeatable ones, I heard in my headset from Chuck Will, the long-time producer of CBS golf telecasts as I stood on the side of the 18th green at Sahalee Country Club. It was near the end of the second round of the 1998 PGA Championship, and I had just radioed the production trailer that David Sutherland’s putt was for a double bogey, not a bogey, as the announcer had just reported on the air. Chuck’s expletive-laced response to my correction was so emphatic because whatever score Sutherland got was going to be the cut line for the tournament. If they went with my correction, and I was wrong, it was really a big deal since it would expose the network to ridicule from their rivals in the print media. “So, are you sure?” asked Chuck, “because we’re going with your call.” With conviction in my voice and doubt in my mind I said, “I’m sure.”

I’m relatively smart, I can count to six, and I clearly saw everything that happened. Why then would I have doubted myself? It’s simple. I always feel I am wrong because growing up I had a different way of doing things which meant I was constantly being told I was wrong. However, what started out as a weakness has turned into a strength, at least in my line of work as an investment advisor, as I have learned not to act on my feelings. 

I don’t act on my feelings when it comes to investing because of what I have learned from research in behavioral finance. According to Nobel laureate, Daniel Kahneman, in environments that are not sufficiently regular enough for someone to pick up and learn cues, expert intuitions cannot be developed. .He says the stock market is such an environment, which means feelings about market movements or stock price changes cannot be trusted.  

Since feelings cannot be trusted investors need to trust statistics. Unfortunately, the number aren’t perfect. They tell you what to expect. But that doesn’t mean the unexpected cannot happen, especially in the short run. That’s because of the uncertainty of markets. So, for shorter periods of time unexpected returns will often dominate expected returns. 

What is expected, in the long run, is that stocks with low ratios of price to book value (value stocks) will outperform stocks with higher ratios (growth stocks). Historically, for any 3-year period that is true about two-thirds of the time. But that’s not what happened for the most recent 3-year period. Instead of outperforming, value stocks underperformed by the largest amount since 1926. So, while the S&P 500 Index was up 10% (year to date) and Facebook, Apple, Amazon, Netflix, and Google were up a whopping 56%, value stocks were down 10%. That’s a concern for broadly diversified portfolios that balances both growth and value stocks, as we do. 

When such an outlier event happens, you feel like you did the wrong thing and need to make changes to correct the situation. But that would be “…wrong statistically,” says Kahneman because the long-term probability favors staying the course. However, as we have learned, probabilities are not guarantees and the unexpected is always possible.   

Stock markets are different than golf telecasts, so Chuck Will could demand right answers. Investors aren’t so lucky. They can only rely on long-term statistics, which means accepting the fact that you can’t always be right, so you need to be prudent. And prudence means sticking with the expected over the unexpected, especially in the midst of uncertain times that are exacerbated by the COVID-19 pandemic. So, with doubt in my mind and voice, but conviction in the numbers, I say, “I’m sure that we are doing the prudent thing by diversifying broadly.”

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