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Past Experience Can Lead You Down the Wrong Path This Time



December 06, 2009 – Comments (14)

A while back I read a blog with lots of recommends that did the kind of analysis that John Mauldin describes in this question and answer:

 Damien: Switching topics, can you explain why Wall Street economists tend to be permabulls or permabears?

John: Mostly because their job descriptions create agendas. There are very few like David Rosenberg who feel they have the independence they need. Also, a lot of them are traditionally trained. So, they’re trained to create tools, and they think economics is a science. It’s not. It’s an art. And quite frankly, when you treat it as an art form you have a better chance of getting the numbers right.

Damien: Can you explain what you mean by that?

John: All of the economic models are created on past performance. For instance, right now the economic idea du jour is what the recovery will look like. So, economists go back and average the eight post-war recessions and say, “Look, this is what the average was and this is how it responded.” Well, making a prediction based on that only works as well as the underlying fundamentals of the recession.

This is a deleveraging, deflationary, asset-bubble-bursting recession. We’re going to lose 8-10 million jobs. We’re back to where we were in early 2000 in terms of jobs. Over the next five years, just to keep up with population growth, we must create another nine million jobs. Plus, we’ve got another almost five million people who are underemployed. And the Census Bureau took 450,000 people off this year because they said, “They’re no longer looking for jobs, and since they’re not looking for jobs they’re not unemployed.” That is a fascinating way of looking at it! Last month you were looking for a job and now you’re so discouraged you’re not looking for a job, so we’re not going to count you as unemployed. That’s a patently silly idea!

 You draw on all the experience in the world, but if you are comparing what happened in other recessions in people's memories the underlying fundaments of those recessions had nothing to do with a deflationary, asset-bubble-bursting recession.

But, people do this kind of thing all the time, make comparison of what has happened in the past without quantifying why it makes any sense at all to compare to the past.

14 Comments – Post Your Own

#1) On December 06, 2009 at 11:45 AM, SkepticalOx (98.52) wrote:

they think economics is a science. It’s not. It’s an art. 

I think this is the key point. Economies and markets are filled with these complex, finicky, and often irrational participants that we have yet to figure out: humans.

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#2) On December 06, 2009 at 1:10 PM, awallejr (34.04) wrote:

Yeah yeah yeah, "this time will be different" argument.  Keep costing people opportunites by scaring them out of the market.  While we all know the phrase "past performance is no guarantee of future performance"  learning from the past is still important.

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#3) On December 06, 2009 at 1:12 PM, FreeMortal (28.60) wrote:

they think economics is a science. It’s not. It’s an art.

This is like saying physics or meteorology is an art.  It discounts all the progress made in the past 500 years.  There is still much we don't understand and much of this knowledge seemingly conflicts. Yet Adam Smith is still relavant today, just as Newton is.

Humans are predictable creatures.  We'd like to think we are in control of our thoughts and immune from influence, but we are still bound to our primative programming.  Axe body spray commercials appeal to teenage boys precisely because they are so predictable.

Sociology, psychology, and game theory all predict human behavior.

Technichal Analysis like Dow theory or Eliottwave theory did very well predicting markets until a critical mass of analysts started using those tools and baking it all in.  Like quantum mechanics, we cannot measure without influencing the result.  Does this make quantum mechanics an art?

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#4) On December 06, 2009 at 2:20 PM, Schwab711 (98.75) wrote:

It is interesting because I was just considering the other day whether I believe the markets to be similar to quantum mechanics. Alas, in my opinion it is not similar. (Note: Quantum mechanics prevents accurate measurements for completely different reasons then the markets do but we are looking at the metaphor I think).

I believe economics is an art because the most efficient market decisions one can make for the long-run are often not the most efficient choice at any time. An example is 'wind power' which has been doing "work" for humans for 5000 years. It is renewable, put it up once, fix it a couple times, and it will transform energy into a usable form over and over. Yet, at no point in the last 5000 years until the last couple years has it been the best economic decision to increase production and technology. Yet, the same reason wind power is the best economic choice today [global warming], is the same reason it has always been the best long-run choice. The 'art' of investing is the x-factor, or common sense, or literally the 'art' of economics. 

Humans by no means are predictable and sociology, psychology, and game theory all thoroughly show this. I take a bus ride from north to south campus everyday for school. This is a 12 minute ride and can go from sparsely populated (8am ride) to jam packed and fists thrown to get on (11am or 11pm on friday nights). I have been watching for 3 years now trying to predict where the next person will sit. I bet you wouldn't be surprised to hear that this little experiment is highly predictable. I can, more often than not, tell you where the next person is likely to sit on the bus. Although, it is the guy who sits next to the one other guy on the bus when all 38 other seats are open that will always throw holes in your model. It is surprising results like this (although possible results) that make economics a science in my opinion. Humans are unpredictable leads to markets that can not be fully defined. 

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#5) On December 06, 2009 at 2:32 PM, devoish (67.86) wrote:

I agree. It is more about analysing the circumstances of this recession. When was the last recession that began with interest rates already at 1%?

How did stocks perform coming out of a fall when so many people had "one click" access to brokers. When was the last time so many people had been so well trained to buy stocks with their retirement money? My grandfather (born 1899) would have laughed at the idea. When was the last time the Chinese could buy US stocks?

The internet is different.

There are so many circumstances that do not match any other time in history that comparisons are difficult at best.  


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#6) On December 06, 2009 at 3:28 PM, SkepticalOx (98.52) wrote:

FreeMortal (56.30)

I think the author wanted to compare economics to hard sciences, such as physics, or that the belief of many economists that economics is a hard science. It is not, it's a social science. He is not the only prominent figure to have critiqued economics in this way (Taleb and even Krugman). Too many economists, who didn't at all predict the crisis, rely on flawed theories and ideas built on efficient markets and rational participants. Many blame this arrogance on the subject to be a reason that helped lead into this crisis. The problem is that too many economists preferred to find a simple and elegant formula to explain economics, instead of looking at the real picture and realizing that humans can't be explained by mere simple formula's. 

Economics may not be an art and nothing else, but it sure is not a hard science. To paint all economists and all of economics under one brush in unfair though, as there are many new fields, such as behavioral economics, that try to address the issues in economics. 

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#7) On December 06, 2009 at 5:13 PM, Teacherman1 (< 20) wrote:

One of my favorite jokes of all time was about a group of professionals who were stranded on a desert island.

They had a huge store of canned goods that had washed ashore with them, but no way of getting them opened.

Each in turn offered their opinion on how to tackle the problem.

When it came time for the Economist to offer his thoughts, he began with the statement, "assume a can opener".

Maybe that they are trying to "assume" too many things at once is the crux of the problem.

Foolanthropy on. 

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#8) On December 06, 2009 at 5:34 PM, SkepticalOx (98.52) wrote:

#7 Or or,

A student and an economics professor are walking down the sidewalk, when they come up upon a twenty dollar bill on the ground. When the student decides to pick it up, the economic professors tells him "don't do that, if it were a real twenty dollar bill, someone would've picked it up already". 

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#9) On December 06, 2009 at 5:56 PM, FreeMortal (28.60) wrote:

I'm glad you brought up the hard/soft science thing.  I find it facinating -and disturbing- how physics continues to open new frontiers of confounding unpredictability. Now we have strong arguments that physics is not quite as “hard” a science as we once thought.  I think we agree that physics is very different from economics (though it does rhyme) and we probably don't want to waste time discussing what is “science” here.

Lets go to the “common sense” notion of the art of investing.  Would that be common sense as in doing what the common person is doing?  Or would that be using one's understanding of the world –science, politics, economics, nature- and applying it to investing? (as an artist relies on his experience in the world to apply his craft)  In the case for the latter, do you assume that your experience is better than an “average” investor; that you will find the inefficiencies because your system of analyzing the market is more holistic or of higher resolution (i.e. somehow better)?  Now, we’ve entered uncommon territory –which is where most of us want to be, but -by definition- were most of us cannot be. 

Maybe you could frame the art of investing -as it is in science- as being able to ask the right questions, something our models do not do so well.  Let’s take Devoish’s excellent question:

“When was the last recession that began with interest rates already at 1%?”

Implicit in the question is the fact that this is an unusual circumstance and any direct comparison to a particular historic event will quickly break down.  How then do we answer this question?  We create models in our heads and on paper based on our experience (which is based on the past).  Rather than apply a parable of history like trace paper, we break it down into smaller models and patterns while constantly tweaking them, improving them, and sometimes throwing them out.

Of course we need to throw out bad theories, but are they all so bad? More like incomplete.  Newtonion laws worked very well for our world until we started dealing with speeds that were a significant fraction of the speed of light.  The theories weren't thrown away but refined and understood in a broader sense. 

Would you say that part of this "art" is appreciating the rhymes of history?

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#10) On December 06, 2009 at 7:07 PM, SkepticalOx (98.52) wrote:


I think you are taking this remark about economics being art to be more than the guy is trying to make it out to be. The very problem with many economists right now is that they preach and follow certain economic rules as if they were natural laws, as if EMH is gravity. This intellectual arrogance is astounding when these very laws which so many economist build their models on are flawed, and when put into practice, catastrophic. Case-in-point: LTCM with their Nobel Economics (which is not even a real Nobel mind you), or the many risk-models that failed last year.

One thing I would like to say though is that even in Art there is science, on why a certain song or a certain painting is more appealing than others.  

"If past history was all there was to the game, the richest people would be librarians." -Warren Buffett  

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#11) On December 06, 2009 at 7:25 PM, whereaminow (< 20) wrote:

Anyone ever read The Pretense of Knowledge by Hayek?  More detail on what is being said here. Treating economics like the physical sciences turns you into a bumbling Keynesian. Treating it like a logical science is the classical method (whose ideas were buried by socialist academiciancs in American universities many decades ago.)

David in Qatar

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#12) On December 06, 2009 at 7:49 PM, devoish (67.86) wrote:

I think "science", "physics", "math", etc is art. 

It just takes someone to see it and show it.

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#13) On December 06, 2009 at 7:55 PM, dwot (28.95) wrote:

Really interesting comments.

There are so many big negatives coming together at the same time this time...

1) excessive personal debt

2) excessive government debt

3) excessive corporate debt

4) rising social costs of an aging population

5) enormous over capacity in retail

6) enormous over capacity in office space

7) enormous over supply of existing homes

8) extreme decline in personal savings rate

9) excessive education debt  for young people

10) insolvent banks

The list can probably go on...

If one was go back and look at these issues and rank then from 1 to 10 as to how bad they were by comparison for each recession, well, how do they compare?  


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#14) On December 07, 2009 at 10:47 AM, Schwab711 (98.75) wrote:

(how do I hyperlink a fool moniker?)



I would bet (1)+(2)+(3) compared to real gdp is approximately similar in all recessions. Excess debt over unrealized expected profits is an easy downfall.

The oversupplies in housing and office space excite me because I think in the next 5-10 years or so something will have to be done with all that square footage. It could make Detroit a dream city for small businesses with square footage being so cheap.

It would be interesting to see that list compared to all the recessions or even the big ones.


I do mean common sense in the latter form. I don't know yet how I see it factoring in  but you have it right.

" Now, we’ve entered uncommon territory –which is where most of us want to be, but -by definition- were most of us cannot be. "

It is the reason Buffett can say he will make above average profits and do it. I don't know why the markets aren't efficient with all the information out there. The only answer could be that everyone investing does read up about it but if there are different camps that teach different techniques then different valuations arise and thus inefficient markets. 

I actually like the comment of math being art. At first my topic was going to lead off with hate for that comment as I am a bias fan of math. But it is definitely an art when you can have a group of people look at the same symbols on a chalkboard and all can arrive with answers distinctly different and equally correct. Not every case or even many cases exist such as this but the principle stands that it is often how you see it. 

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