A note on fallibility

A short piece I’ve been meaning to write for a while now is less on the specifics of investing, but is still very relevant to the practice.

Hindsight Bias

Hindsight bias is the way in which, when things have already happened, they appear to be obvious – or, at least, more obvious than before. Most of us are guilty of it; I often find myself saying things were obvious when looking back, while at the same time being all too aware that when needing to make a firm decision – perhaps on a potential new buy – I’m rather edgy. To say this is very relevant to investing is an understatement; if someone asked me to outline how I think about the markets, I’d probably start by scrapping most of the assumptions underlying classical economics and EMH – that of rational economic man. Investing, to me, is like other games; a constant struggle with, firstly, your mental capacity to assimilate and correctly analyse information, and the more nuanced side of whether you correctly apply your knowledge. I don’t think splitting them up is too granular. The famous economist, Keynes, spent much of his life rewriting the economic rulebook and talking about the unpredictability and inherent humanness of markets – only to almost blow up in the 1929 stock market crash by ignoring his own wisdom and trying to, essentially, speculate.

In short – I think careful self-analysis and the ability to be honest with onself is absolutely crucial. I don’t think it’s a secondary factor in investing, I think it is the primary factor – being an excellent stock picker is precisely like being a fantastic mathematical poker player, with the ability to analyse and compute probabilities in any situation – it is entirely worthless if your emotional and mental control means you never correctly apply it. I guess that’s part of the reason why, while you’ll struggle to find anyone who doesn’t think ‘buying low and selling high’ is smart – come on, it’s obvious! – history tends to suggest that most people don’t actually do it. Momentum would seem to refute that.

Why I bring it up

What sparked off this train of thought was a newspiece on the radio a short while ago. You’ll probably remember that about 3 weeks ago, on April 17th, Tesco confirmed their exit from the US – their Fresh and Easy chain, set up by previous Chief Exec Terry Leahy. When I heard this, I chuckled to myself. This, I said, was obvious. The writing was on the wall years ago; why would Tesco try and compete in such an ultra-competitive and geographically divergent market? Anybody could see that coming. It had been losing money and eating up capex for years, with no success.

Well, sadly – or positively – as a blogger I’m stuck with a record of everything I’ve ever said to keep me intellectually honest, and all in one convenient place. This isn’t something you’ll find of most experts they parade to inform you of the obviousness of any given macro or business event. And I remember writing about Tesco about a year and a half ago, not too long after starting my blog. What did I say on Fresh and Easy then?

Finally, I should address the issue of the thorny US operations. I was unsure on this move – taking on small national players in developing countries is one goal, but challenging the likes of Walmart on their home turf is a different thing entirely…

Looks good so far!

… I found more solid reasoning than I expected in the annual report, though – including a line noting that Tesco believe they now need far fewer stores to break even than previously anticipated. The majority of this year’s losses, they believe, came about from the integration of two dedicated fresh food suppliers – though details on that are scarce. I take pleasure in being sceptical, but I do think that perhaps the pendulum has swung too far the other way in this case. It makes sense to me that the operation needs some decent scale to be profitable, and the US business, as in the chart above, has continued to post strong revenue growth as it establishes itself. There’s a prevailing ‘fear’ in both media and business circles of the American behemoths, but I don’t see any reason why such an internationally successful retailer can’t at least eke out a small profit in the market.

Ho ho ho. It’s easy to pick holes in my logic – even I can see I was simply buying the supermarket’s line in the annual report – but the interesting thing is the way in which, after the event, I held the exact opposite view to the one I had 1.5 years ago. Yes, my opinion might have changed in that time; if you asked me in March of this year what I thought about Fresh and Easy I might have been less positive. Curiously, though, I don’t even remember being so bright on the chances of their US operations. I was convinced that I had long held the view that it was a terrible idea, and went as far as telling others I had written on my blog about it.

It’s easy to sound right

All of this might well be obvious to you – and if it is, then good on you. What it reinforces for me, though, is twofold. Firstly; the opinions of people commenting after the event are completely irrelevant. News articles are the worst for this – they are experts in backwards justification, in coming up with reasons that were never obvious until after the event has already happened. This is of absolutely no use in investing. Secondly, though; don’t get ahead of yourself. Investing is a game of stacking your odds in the favour, since we can never know exactly what will happen with such a huge human element. Keeping track of exactly what you said and why you said it is an excellent way of giving yourself a dose of humility, but also a cause for self-reflection.

I judge my investing on the portfolio’s performance, but with a healthy dose of scepticism given the short timeframe and the relatively small number of stocks involved. That, to me, seems to be the fairest way of seeing exactly where I’m right or wrong – if I back up my thoughts with cash. I’m cautious of anyone who does otherwise – and it’s not hard to find the services that offer stockpicks in enormous volume, then always seem to be telling you about how right they were while neglecting to inform you of the misses.

It’s easy to sound right – it’s much harder to be right with any consistency. An impossible dream perhaps, but one I think we can all aim for!