Are you an optimist or a pessimist? Few questions are as basic or as revealing about our fundamental outlook on life and the world around us. Today I’d put myself in the “optimist” column albeit with some qualifications. To my family and friends that may come as a surprise. Indeed, my outlook has evolved over the years — today I’m an optimist by choice rather than disposition.
Happiness and Optimism
Culturally we tend to view those who warn us of impending doom as idiosyncratic thinkers, prescient iconoclasts, or even misunderstood geniuses — if not in those exact terms, at lease imbued with superior intellect. Consider this article, Are Happy People Dumb? from no less a paragon of thought leadership than the Harvard Business Review. Just in case the title equivocates, it opens thusly:
Happy people are not the smart people.
I felt the author dealt with happiness in a narrow sense of our immediate reaction to life circumstances. The article actually went on to make a different point (it’s worth a read so I won’t spoil it for you). But the sentiment reflected in its opening sentence is not uncommon. Happiness, some thought, is only reserved for the oblivious masses, the happy-go-lucky man-on-the-street, or worse yet, the dumb-as-a-door-knob brother-in-law. A person moderately read, traveled, and spent five minutes thinking about the future can see that wealth polarization is worsening, ideological differences are getting more entrenched, middle class is going nowhere, white collar jobs are being displaced by AI, our international allies are abandoning us, China is taking over the Pacific, war is brewing everywhere, OH MY FXXXING GOD THE WORLD IS COMING TO AN END!!! I was like that, a worrier by nature. I was taught to plan for the worst and hope for the best. But somehow I was preoccupied with the plan part and never allowed myself the hope part.
There have been claims of a “happiness gene”, although I find the evidence a little wanting. Certainly much of our immediate mental responses to external events are deeply rooted in our psyche, they’re called “gut reactions” for good reason. We know that when speedy decisions are needed, out mind apply certain heuristics, i.e. short-cuts borne from experience, rather than lengthy deliberation. As a result of our evolution, the heuristics tend to highlight signs of danger because of the risk/reward asymmetry — our ancestors were much better off assuming the rustling of leaves was from a mountain lion beneath than an errand gust. It’s quite possible for the tendencies of these heuristics have a genetic or neurochemical basis that also spills over to longer term decision making. Therefore, we need to overcome our innate dwelling on the negative, in order to make an accurate forecast by assessing the probabilities and consequences of potential outcomes; it may even be an acquired skill. The history of stock markets has shown optimism of this sort, a positive, thoughtful outlook on the future, to be by far the more profitable orientation.
Market and Economic Outlook
As a PM investor since 2002, I’ve lost count of the dire warnings I’ve read on websites like SafeHaven, DailyReckoning, FinancialSense, GoldSeek, Gold-Eagle, 321Gold, and last-but-not-least, ZeroHedge. Pessimism sells — I’m proof: fifteen years ago I bought into the doomsday thesis hook, line and sinker. I bought into, and lost money in, both David Tice’s and John Hussman’s funds. It took me a long time to come around to the other side which was an intellectual process. To start, there was one fatal flaw with the bearish thesis: it didn’t work for investors. Note I didn’t say it’s wrong because that’s a rabbit hole of theories about manipulation and what should have, would have happened. Instead, it’s an incontrovertible fact that the bearish thesis has made its believers poorer.
It’s a truism that the market goes up most of the time, but that is too simplistic an answer to why the bearish thesis did not panned out. I can think of two reasons why.
- One favorite line of attack on the “phoniness” of the stock market’s recovery is to point out that the recovery has left much of the middle and working class behind. Much of the gloomy picture is accurate, although I take issue with some interpretation of the data, such as the stagnant wage growth by noting that average wage is highly age dependent such that a typical worker is still getting more pay as his career advances. It’s undeniable that some are left behind by the digital divide, and unequal wealth distribution is both a humanitarian concern as well as a social ticking bomb. However, looking at it unemotionally, unequal wealth distribution is evidence for both the compounding effects of the knowledge economy and the diminishing economic footprint of the disaffected. Unevenness of recovery does not mean it’s false, but rather it’s early and has legs. Conversely, the top is not far away when everything everywhere is booming.
- The biggest mistake the bears made was to underestimate the resiliency of the system, by which I mean the policy tools the central bankers and governments around the world were willing to adopt. Sacred classic economic principles turned out to have its basic assumptions abrogated. Fore example, many was sure the expanding money supply was going to lead to inflation. Nine years later they say, oops the velocity of money collapsed. Oops indeed, that was one expensive mistake. I see the China bears making the same kind of mistakes again.
Like it or not, central bank and government intervention in the economy is likely to stay or even expand (see the recent Felix Zulauf interview). I choose to take advantage of the situation rather than make my portfolio a statement of what I believe things should be. As Keynes once said, “When the facts change, I change my mind. What do you do, Sir?” It was nice to have read Fredrick Hayek, Milton Friedman and Ayn Rand, but one can’t make money with Austrian economics and sound money principles. I too see nobility in the suffering of a starving artist — the operative word being “starving”.
Today I still have a substantial allocation to PMs based on their portfolio diversification characteristics, but I don’t expect a near or even medium-term monetary collapse. Readers are no doubt aware that my portfolio is currently leveraged long equities, from which some may surmise that I’m “optimistic” about the stock market. That’s not incorrect, but the whole picture is more nuanced. As always, the time frame plays a critical role.
- As the title 1998 (relative to the dot com bubble) would suggest, my base case scenario doesn’t call for a top in the stock market until 2019.
- The Next Bear market I anticipate to be a cyclical one within a secular bull market, for a decline of about 30% lasting 12-18 months.
- Nonetheless, my 10-year equity return projection is under 4.3%. One way to get there is to round-trip in three years, then grow 6% for 7 years. That’s equivalent to 4.2% nominal for 10 years. In other words, I expect the current bubble to pull-forward a lot of the future returns. Based on this projection, the 4% rule for the Jan 2000 retiree is in jeopardy. Take a 70/30 initial allocation as an example, even if it were to make it to 2030, the portfolio would be too depleted to support the retiree much longer (see also).
- I’m more hopeful after this next 10 years, and for the world as a whole. The technology trends of AI/ML etc. will take many decades to play out. Even if the US doesn’t grow as it did post WWII, the global economy just might.
I would consider this “tempered optimism”, no outright disaster, but the economic manipulation is not consequence-free either. What matters more, clearly, is what to do with this understanding.
Life in General
Looking back I believe I’ve made a case for not being an out-and-out pessimist, but probably not a strong one for being an optimist. For that we need to look outside the markets. In the larger picture, there is one and only one reason that makes me fundamentally optimistic about humanity: our knowledge is still expanding: in fact it’s being generated and disseminated at an unprecedented pace. Knowledge, once obtained, cannot be destroyed, but compounds for future generations. As long as humanity survives, and knowledge expands, there will be progress. Besides given me hope for humanity, this line of thinking has offered me clarity in the overall hierarchy of values.
On a more personal level, my optimism comes from my ability to think for myself, to adapt to change, and to raise a loving family. My active approach to investing as well as my appetite for risk are direct expressions of that optimism. I’d like to think that my path to where I’m today has not contradicted that belief. I have not always thought this way; I like this way much better.
May our future be brighter than the past.
None of the above is investment advice, the standard disclaimer applies.