Weekly Update

The Seduction of Pessimism


Published June 23, 2017


We strive in our weekly blog posts to present all the major prevailing views on markets. Nevertheless, we have marveled over the years about the staying power of the doom-and-gloom crowd. How is it, in the midst of a long running bull market that the doom and gloom crowd has any remaining followers at all? They have been steadily and consistently wrong. Yet their amplified voice carries on, especially among retirees, while the voice of those who argue things are just fine usually get drowned out except in institutional circles. The article below from Morgan Housel rummages around in this arena of optimism and pessimism finding some interesting points along the way we think.

“Pessimism is intellectually seductive in a way optimism only wishes it could be.
Tell someone that everything will be great and they’re likely to either shrug you off or offer a skeptical eye. Tell someone they’re in danger and you have their undivided attention.
Hearing that the world is going to hell is more interesting than forecasting that things will gradually get better over time, even if the latter is accurate for most people most of the time. Pessimism can be hard to distinguish from critical thinking and is often taken more seriously than optimism, which can be hard to distinguish from salesmanship and aloofness.
Y2K got more media attention than any individual tech company.
SARS got more attention than the massive decline in HIV mortality.
Forecasting $250 a barrel oil in 2008 sparked immediate congressional hearings. Forecasting the bankruptcy of oil giants as electric cars proliferate sparks immediate giggles.
On one hand it makes sense. Daniel Kahneman once wrote: “Organisms that treat threats as more urgent than opportunities have a better chance to survive and reproduce.”
But on the other hand it’s crazy. We don’t just respond faster to pessimism. We coddle it for longer than is necessary. Optimism demands facts and is ditched at the first sign of trouble. Pessimism can be grown from a crazy thought and clutched indefinitely.
Six years ago I interviewed Jeremy Siegel, a Wharton finance professor with a reputation for investment optimism.
He was, in 2011, bullish on the stock market. He pointed to history. Over all long historic periods the stock market has produced positive returns after inflation.
A journalist in the room rebutted that stocks had actually shrunk over the previous decade.
Siegel wasn’t phased. Yes, 10-year returns were bad. But he doesn’t care about 10-year returns. It’s too short a period. Over the previous 20 years – 1991 to 2011 – the market had actually performed above average.
“The past decade has been frustrating,” he said. “But that’s only because we had unreasonably high returns in the 1990s. The last 10 years has just offset the previous decade.”
Siegel sidesteps pessimism not because he thinks bad stuff doesn’t happen, but because he has a longer time horizon than most. The difference is subtle but helps explain why pessimism sounds smart amid a backdrop of general improvement.
Anything competitive – markets, businesses, countries, careers – moves toward improvement by breaking down what isn’t working and exposing weaknesses. Which means improvement over the long term has to be interrupted by short-term adversity. Pain, regret, trudge, and bullshit is the fuel for advancing and the cost of admission you have to pay to enjoy the benefits of any long-term improvements.
The difference between pessimism and optimism often comes down to time horizon. If a recession or downturn is the end of your show, you should be pessimistic. If it’s a bad commercial during an otherwise great episode, you should be optimistic.
Since short-term shocks are more frequent and recent than long-term gains, pessimism usually sounds smarter than optimism because it’s easier to recall.
Optimists are often ridiculed as being oblivious to how risky the world is. I’ve found this to be a bad reading. They’re often quite aware of risks, but equally aware of risks being the soil optimism eventually grows out of.
Gas was expensive in the 1980s. So people adapted and bought small cars and oil producers drilled a lot of oil. That made gas cheap in the 1990s. So people adapted again bought SUVs and oil companies packed up and abandoned fields.
Then gas got expensive in 2008. And despite a long history of adaptation, we basically thought things would stay that way forever. Peak oil became a default assumption. Four-dollar gas was seen as the new floor.
But we adapted again. Hybrid sales surged. Oil producers used high prices as an incentive to discover new drilling techniques. Prices eventually fell and the pessimists went quiet.
Despite an awareness of how powerfully we’ve changed in the past, it’s too easy to underestimate our ability to change in the future. Psychologists call this the end of history illusion. In people, it’s the tendency to realize that your tastes and values have changed in the past while underestimating how much they’ll change in the future.
It’s a reason pessimism is so seductive.
Most things in business and investing have to be pushed to their limits once in awhile, if only to see where the limits are. “Unsustainable” is the most common state that businesses and markets reside in.
If you underestimate our ability to adapt to unsustainable situations, you’ll find all kinds of things that currently look bad and can be extrapolated into disastrous.
Extrapolate college tuition increases and it’ll be prohibitively expensive in 10 years.
Extrapolate government deficits and we’ll be bankrupt in 30 years.
Extrapolate a recession and we’ll be broke before long.
All of these could be reasons for pessimism if you assume no future change or adaptation. Which is crazy, given our long history of changing and adapting. But convincing ourselves of future change is hard to do, so pessimism is easy to latch onto.
It’s also why every past market crash looks like an opportunity, but every future market crash looks like a risk.
In 2004 the New York Times interviewed Stephen Hawking, the scientist whose incurable motor-neuron disease has left him paralyzed and unable to talk since he was 21 years old.
Through his computer, Hawking told the interviewer how excited he was to sell books to lay people.
“Are you always this cheerful?” the Times asked.
“My expectations were reduced to zero when I was 21. Everything since then has been a bonus,” he replied.
This is an extreme example, but some degree of it applies to everyone. Expecting things to be great means a best-case scenario that feels flat. Pessimism reduces expectations, narrowing the gap between possible outcomes and outcomes you feel great about.
Maybe that’s why we cling to it. Expecting things to be bad is the best way to be pleasantly surprised when they’re not. Which is something to be optimistic about.”

Market Update

Summer can often be a mix of slow market activity combined with occasional shocks as participants wander off to vacations and trading volume thins. After two consecutive losing weeks for the market-leading Nasdaq 100 (QQQ) investors came into the week digesting Amazon’s blockbuster purchase of grocer Whole Foods while wondering if oil prices would ever stop falling. Monday’s session brought further downside in crude oil but a solid rebound in the Nasdaq. Tech shares pushed the index +1.4% higher as buyers stepped in to halt the recent dip. Stocks gave back much of those gains Tuesday though strength in biotech stocks was notable. Stocks offered a split picture Wednesday with biotechs having another big rally while energy shares remained under pressure and financial stocks slumped. On the day the biotech move lifted the Nasdaq +0.7% while the broader market was flat. Another flat day Thursday with the Senate’s healthcare bill emerging to cheers among surging healthcare stocks. Software heavy Oracle kicked out a big earnings report. But it failed to move the Nasdaq beyond flat. Friday saw a modest tick higher for stocks with oil rebounding a bit and cyclical stocks joining tech stocks in finding buyers.

For the week, the Nasdaq 100 (QQQ) rebounded to recover the prior week’s downdraft with a +2.24% gain. The S&P 500 (SPY) was weighed down by weakness in energy and financial shares but managed a +0.20% week. The lagging small-cap Russell 2000 (IWM) likewise held to a slight gain at +0.36% for the week.

Warm wishes and until next week.