Are You an Investment Historian or a Futurist?

Historians: The Pros

Broadly speaking, investors either rely on the past or feel free to ignore it. Those in the first group are historians, while the second are futurists.

The investment management company GMO is the preeminent example of a market historian. Its well-known forecasts of future asset-class returns consist largely of anticipating reversions to the mean. When an investment’s price is below its historic norm, GMO expects that asset class to post a healthy seven-year return. If its price is above the norm, though, GMO expects a lackluster harvest.

That approach worked beautifully entering the 2000s. The financial markets had flocked to growth stocks, while most other securities had languished. GMO accordingly distrusted that which had become popular while advocating pretty much everything else. For GMO, the investment math was simple. Growth companies deserved to trade at a premium, given their attributes, but their cost had become exorbitant. Avoid them until further notice.

Spot on! GMO’s December 1999 predictions were astonishingly accurate. The company’s researchers evaluated 11 different varieties of stocks, bonds, and cash, sorted by geography and company size. To the first degree of accuracy, they nailed every estimate. That achievement, quite naturally, made GMO’s reputation. When the decade began, the company was suffering client redemptions. Ten years later, it was highly feted and attracting new business.

Such is the historians’ advantage. Looking backward enables them to distance themselves from the frenzy of current events. As GMO co-founder Jeremy Grantham wrote in early 2009, during the throes of the global financial crisis, buying stocks when blood runs in the streets is problematic because “formerly reasonable people start to predict the end of the world, armed with terrifying and accurate data.” Without a concrete plan for reinvesting one’s cash, “terminal paralysis” will likely result. Anchoring on history resolves that problem. It provides a “battle plan for reinvestment.”

Historians: The Cons

There are two drawbacks to relying on history. One is that reversion to the mean can take so long that when it finally happens it is indistinguishable from being wrong. Another is that history truly does prove a false signal because things have changed. Whether GMO has endured the first or second fate can be debated, but its mistake is indisputable. After embracing US equities in 2009, GMO quickly soured on them, as stock prices rallied. Since 2013, the GMO has consistently predicted ongoing real US stock market losses.

GMO’s fixed-income forecasts have largely been correct. (Admittedly, that has not been much of a challenge because future bond market returns tend to correlate closely with current yields. The same does not hold for stocks.) Regrettably, that accomplishment was largely academic. When setting asset-class expectations, what counts is getting stocks right. Because equity returns vary so widely, the amount of stock market exposure largely determines portfolio results.

Futurists: The Pros

Futurists have the opposite strengths and weaknesses of historians. Perhaps the best illustration of their potential superiority is an outlook that went wrong. In 2009, many institutional investors, and the consultants who served them, believed that the previous year’s events had signaled a sea change. The time for US stocks was over. In the new era, the winning investment strategy would be to pair bonds from slow-growing developed nations with stocks from this century’s leaders: the emerging markets, especially China.

Their investment recommendations, funnily enough, resembled those of GMO: Avoid US equities, expect low returns from bonds, and make your real money elsewhere. (Besides emerging markets, GMO has long favored real assets such as timber.) However, the motivation was entirely different. As historians, GMO looked backward when setting expectations. In contrast, the promoters of what was called the New Normal unabashedly looked ahead. The past was over.

That approach would have been wonderfully profitable … had the analysis of the New Normal’s proponents been correct. It was not. Many of the details matched their expectations. China’s growth did continue unabated, the economies of the developed markets did slow, and global government regulation did increase. However, those events proved unimportant in the end. What drives equity prices are per-share earnings—and US companies grew those furiously.

In 2009, the futurists were on the right track. Things were different after the global financial crisis. Unfortunately, while the New Normal supporters correctly identified that an opportunity existed, they failed to draw the correct conclusion. Right idea, wrong execution.

Futurists: The Cons

The primary disadvantage for futurists, as we have just witnessed, is the difficulty of finding the correct plan. In that respect, historians have it easier. Although determining historic norms can be challenging, because different measurements reach different answers, their main obstacle is psychological. As Grantham wrote, investment historians must be disciplined. It’s one thing to know what one should do based on the research. It’s another thing to follow through.

For futurists, insufficient insight, not mental strength, is the barrier to success. Understanding what will be is hard. Further complicating that task is the noise of the here and now. I vividly recall the public mindset in the spring of 2009. Politicians of both major parties loudly condemned Wall Street. Stockbrokers were named and shamed in national publications because they had been awarded trips to Hawaii from their home offices. The people had seen enough; the revolution was on.

It was not on. Fifteen years later, the public couldn’t be bothered about the size of stockbroker bonuses. Succeeding as a futurist requires being able to distinguish temporary outcries from the real things. That is a tough assignment.