This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Mark Eshman, co-founder and CIO of ClearRock, an SEC-registered investment advisor with offices in San Francisco and Sun Valley, Idaho.
“We often decide that an outcome is extremely unlikely or impossible, because we are unable to imagine any chain of events that could cause it to occur. The defect, often, is in our imagination.”
—Amos Tversky and Daniel Kahneman
We can find some scientific solace in an otherwise-wildly unpredictable year through the words in yet another brilliant Michael Lewis book, “The Undoing Project,” in which he brings to life the remarkable friendship of two Israeli psychologists whose ideas changed the world.
Tversky and Kahneman’s partnership that began in the 1960s—and ultimately won them the Nobel Prize in Economics—produced the foundation of what we now call “behavioral economics,” helping us understand why human beings repeatedly misjudge probabilities when making decisions.
As Lewis writes, “The more easily people can call some scenario to mind … the more probable they find it to be. Any fact or incident that was especially vivid, or recent, or common … was likely to be recalled with ease and so be disproportionately weighed in any judgment.”
In other words, instead of rationally calculating the correct odds of the outcome of an election, people tend to focus on “mental models they’ve formed in their heads.” Clearly, predicting anything, much less a “surprise,” is a difficult task, but by studying behavioral economics, one should at least be able to recognize and identify these biases before making unwise decisions.
It is once again in this spirit that ClearRock has created our “Top 3 Surprises.” The idea is to hang our hat on three predictions that may be at odds with Wall Street’s conventional wisdom for the coming year. We may or may not find investable ideas in these “surprises,” but we feel they are worth pondering nonetheless.
Our hope is that by considering ideas outside the mainstream and by consistently applying a thoughtful decision-making framework to our process, we can improve our investment outcomes each year.