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The Ongoing Investor Perils Of Recency Bias
Why was last year's historic 60/40 drawdown so shocking to so many investors, professional, amateur and everyone in-between?
Well, anything that's "historic" (and particularly things that are historically bad) tends to shock people, but outsized losses for stock-bond portfolios in 2022 were uniquely uncomfortable because they called into question the correlation assumption that underpinned two decades of asset allocation dogma.
Stock and bond returns were supposed to be negatively correlated.
I’ve bought plenty of short-term CDs and Treasuries this past year – 4.8%-5% is fine for me. But what I really wanted to pounce on was something similar in the long term. Now I’m regretting letting 4.6% 20-year Treasuries go in November. Do you think that was the peak?
Wow excellent beginning where you summarized years in a few paragraphs.
And thanks for the ending summary of McElligott, he’s really got his finger on the pulse of the aggregate of algorithms.
Low volume leads to quite a roller coaster (unless you’re sitting in a big chair cushioned with high yield Treasuries).
The whole concept of Just-in-Time logistics is absolutely seductive to firms trying to squeeze out another year of profit growth. The trouble with this idea is that for JIT to work, every link in the supply chain must work perfectly or the system shuts down. Inventory is the grease that reduces the need for pure perfection. For JIT to actually work, someone, somewhere in the supply chain must have enough slack to keep the system running. Line balancing problems in production are just like supply chain breakdowns. One needs a bit of slack to decouple chained operations and keep everything moving. Whether its the Texas power grid failure two years ago, the ongoing water problems in the Western US, or the inability of SW Airlines to meet its scheduled flights, the lack of slack in our system, chosen on purpose to maximize profits will eventually bite us and show that the risks we are trying to ignore are, nevertheless, still lurking.
As I read this post, I remembered something I always told my students (even though they paid no attention) all assets are essentially a type of inventory. The same rules required to keep them moving smoothly apply to any asset. The GFC of 2008 was essentially a supply chain asset inventory problem. All chained systems in our society need some slack to keep functioning smoothly. The whole idea of a bank is that not everyone will need their deposited assets at the same time so the bank can make promises it generally can keep. However, a disruption in the chain can break the system down in nothing flat. Judging from the mess the downfall of one regional bank with concentrated risks could make, imagine what would happen if the dominoes really started to fall in the derivatives market. What I see in H’s daily posts are reports of the problems arising from efforts to keep the financial system in balance and the search for slack. It occurs to me that although it seemed like the GFC was a Black Swan tail event, in fact, the occurrence of this type of problem on a regular basis is virtually guaranteed, given the size and complexity of the system. The maintenance of all inventory/slack costs money. Repeated studies have shown that a dollar’s worth of inventory available all year, costs between 15 and 25% to maintain. It is the insurance premium to keep the system running smoothly. Cutting that slack creates the same risk as dropping car or house insurance. Without a claim, it’s all gravy. But needing it and not having it is a potential disaster.
excellent comment, Mr. Lucky … stay healthy and well…