Statistics genius Nate Silver spoke at a conference in Seattle a few weeks ago. He made a point that stuck with me. Radar technology was in its infancy in the early 1940s. To protect U.S. interests like the Pacific Fleet in Pearl Harbor, Navy planes circled the Hawaiian Islands, searching for threats. "You were just sending a couple of planes that would go around a circumference until they ran out of fuel and then head back to base," Silver said.
Alas, the Japanese military knew exactly how large that circumference was, and in November, 1941, sent its aircraft carriers just beyond the range our reconnaissance planes could fly. On December 7th, it attacked.
"My point is that everyone has a viewpoint," Silver said, and that viewpoint usually shows just a fraction of the whole picture. There are important events sitting outside your viewpoint that, if you knew about them, would totally change how you view the world.
There's a similar problem with investors and history. Your view of history is heavily influenced by your own experiences. But just like the Navy, your own experiences are an incomplete view of the world, arbitrarily blocked by when and where you were born -- the equivalent of reconnaissance planes with limited fuel range. There are important events sitting outside your viewpoint that, if you experienced them, would totally change how you view the world.
Take what the stock market did in your teens and 20s. There's a body of research showing that events experienced in your youth shape how you'll feel about a topic for the rest of your life. And depending on when you were born, stock market performance has ranged between dreadful and phenomenal during your teens and 20s:
If you were born in 1970, stocks increased nine-fold during your teens and 20s (adjusted for both inflation and dividends). This probably had a profound impact on you. You saw your parents gawk at their 401(k) statements, watched the E*TRADE commercial during the Super Bowl, and maybe had friends who retired early without much effort. To you, the market was a place easy fortunes could be made.
If you were born in 1950, stocks went almost nowhere during your teens and 20s. You probably saw your parents shake their head in frustration as what little gain stocks produced were eaten by inflation. It's unlikely you knew anyone who made a fortune in stocks, and you probably knew several who lost one. To you, the market was kind of a joke.
Neither of those views is "right." They're both just half-baked observations of the market's boom-bust cycle. But it's hard to convince people of that. To them, history is what they experienced. Everyone assumes they can think objectively, but if you were born in a different year you would probably have a totally different view of how the stock market works.
It's the same with inflation. I started paying attention to the economy when I was about 16. Since then inflation has averaged 2.3% per year, and the highest it's been is 4%. When my parents were the same age, inflation had averaged 7.1% per year and the lowest it had been was 4%. We've had totally different experiences, and those experiences shape how we think about inflation. But both are arbitrary and incomplete, and both could be dangerous. My experience may fool me into discounting the risk of future inflation, and my parents' generation may overestimate it.
Part of the reason people are bad at predicting the future is because everyone thinks the future will resemble the past, and people have totally different definitions of what the past is, biased to our own experiences. As Silver might say, everyone has a viewpoint, and that viewpoint usually shows a fraction of the whole picture.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.