Why there’s nothing easy about ‘easy money’

Notion that past gains were inevitable and future is murky is bedevilled by hindsight bias

“Investing is simple”, as Warren Buffett once quipped, “but not easy”. Photograph: iStock

“Investing is simple”, as Warren Buffett once quipped, “but not easy”. Photograph: iStock

 

Stocks have more than quadrupled since the nadir of the global financial crisis in March 2009, but things will be tricker going forward. After all, the easy money has been made – right?

Not even the biggest bulls predict similarly large gains over the next nine years, but investors should be wary about the idea of “easy money”, suggests Morgan Housel of the New York-based-based Collaborative Fund.

In a recent tweet, Housel pointed out the “easy money has been made” line has been doing the rounds for the entirety of the current bull market. “The easy money’s been made”, headlined Barron’s in November 2009. “The easy money has been made”, said Morningstar in December 2010. The same wording was used by TheStreet in May 2012; by Morningstar (again) in December 2013; by Barron’s (also again) in October 2014; and by CNBC in March 2015 and January 2016. “The easy money has already been made”, said Marketwatch and Zacks in November 2011 and June 2017 respectively.

When markets bottomed in March 2009, there was little talk of 'easy money'. Earnings were plunging at a rate unseen in history

Housel didn’t refer to 2018, but a quick Google search confirms the headline has already been used multiple times.

Hindsight bias

This market cliché gives the impression the big market gains in the recent past were inevitable and that any fool could have bagged them, but that the future is altogether murkier. The problem with this narrative is it is bedevilled by hindsight bias.

When markets bottomed in March 2009, there was little talk of “easy money”. Earnings were plunging at a rate unseen in history and surveys showed record levels of pessimism. Just days after stocks bottomed, economist Nouriel Roubini, lauded for having predicted the global financial crisis, warned a further fall of 40 to 50 per cent in global markets “could not be ruled out”, adding investors should “brace ourselves for new lows on US and global equities in the next 12 to 18 months”. Throughout 2009 and 2010, cautious investors warned the market rebound was little more than a bear market rally. The S&P 500 nearly fell into a bear market in 2010, suffering an intra-year correction of 16 per cent, and endured an even bigger decline in 2011, when a variety of shocks – Europe’s sovereign debt crisis, US debt losing its prized AAA status after S&P’s rating downgrade, mounting fears of global recession – roiled markets.

Nor was there much talk of “easy money” in 2012: “the corrosive effect of excessive debt, the softening US and global economy, the ‘fiscal cliff’, the implausibility of a European solution, the probability of a hard landing in China and the prospect that corporate earnings estimates were far too high . . . these negative stories are carried in the Wall Street Journal every day”, warned Comstock Partners. The S&P 500 soared 32 per cent in 2013, its best year since 1997. Easy money? Hardly. Respected Deutsche Bank strategist Jim Reid cautioned investors in late 2012 to expect “huge risk-off moments”, saying Europe might require “extraordinary” central bank intervention to “avoid the unthinkable”. 2014 brought the usual bear market predictions as well as a warning from influential money management firm GMO that the S&P 500 was overvalued by 75 per cent.

Stocks gained in 2015-16, but investors had to endure a global bear market during that time. Ironically, CNBC’s aforementioned warning in January 2016 that the “easy money has been made” came just before stocks bottomed in February, prior to a furious market rally. Looking back, buying at that juncture seems like “easy money”, but it didn’t seem that way at the time. By July 2017, iconic investor Howard Marks was warning the “easy money in this cycle has been made”, only for stocks to march relentlessly upwards as the year progressed. Marks, one of the most respected commentators in the investment world, repeated this warning in 2018, but his memory may be playing tricks on him up as to how “easy” the current cycle has been. “One thing is indisputable: the rally in financial markets worldwide has outpaced the fundamentals”, he warned in January 2010. “The profits ahead won’t be easy money.” Today, concerns regarding valuation, the sustainability of record profit margins, and rate hikes are centre stage, but these are not new concerns. In mid-2009, those same issues were commanding market headlines.

‘I knew it all along’

“As human beings we have a tendency to forget how we used to feel,” says Stuart Canning of M&G Investments. “The ‘era of easy money’ was actually one of deep fear and discomfort.”

Canning’s point is echoed by behavioural finance guru and Nobel laureate Daniel Kahneman. “Once you adopt a new view of the world (or of any part of it), you immediately lose much of your ability to recall what you used to believe before your mind changed”, Kahneman writes in Thinking, Fast and Slow.

This hindsight bias was first established by one of Kahneman’s students, Baruch Fischhoff, who conducted a survey in 1972 asking respondents to estimate the likelihood of several outcomes of Richard Nixon’s diplomatic trips to Russia and China.

If it was a foregone conclusion that monetary policy would drive a stock market boom, why were the critics sitting in cash or gold?

After the trip, Fischhoff asked respondents to recall the probabilities they gave. If an event occurred, respondents exaggerated the probability they had assigned to it. This same “I-knew-it-all-along” effect has also been found in studies involving predictions of the OJ Simpson murder trial and the impeachment of Bill Clinton. It is, notes Kahneman, “a robust cognitive illusion”, one people typically continue to exhibit even after being made aware of the problem. Psychological research indicates there are three aspects to hindsight bias – memory distortion (“I said it would happen”), inevitability (“it had to happen”) and forseeability (“I knew it would happen”). Hindsight bias causes obvious problems for investors. It breeds overconfidence, making complex events seem simplistic and predictable. It drives unrealistic expectations of fund managers, who are expected to foresee the unforeseeable.

Distorted memories

Worse, by distorting memory, it stops investors from learning from their mistakes.

Ritholtz Wealth Management’s Ben Carlson recently tweeted that anyone who predicted nine consecutive years of stock market gains in 2008 would have been “laughed out of the room”. Carlson received much pushback for this seemingly uncontroversial tweet, the gist of which was that the stock market boom was inevitable, an obvious product of central bank manipulation through low interest rates.

Such sentiments are “a clear misrepresentation of the past”, said Carlson, who cited headlines from every year between 2009 and 2016 warning the Federal Reserve was “running out of ammo”. Commentators warned central bankers were behind the curve; that they needed to raise rates sooner, or not raise rates so quickly; that the end of quantitative easing would result in a crash.

If it was a foregone conclusion that monetary policy would drive a stock market boom, why were the critics sitting in cash or gold? “Why didn’t they take part in the manipulated market if it had nowhere to go but up?” asked Carlson. “This is a case of moving the goalposts because none of this was a foregone conclusion”. In retrospect, everything is obvious, but “easy money” is rarely easy. Even when the evidence does pile up in one direction – stocks were very cheap in March 2009, there’s no denying that – it’s not easy to pull the trigger.

“Investing is simple”, as Warren Buffett once quipped, “but not easy”.

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