One of the most popular sayings in discussion of the finance industry these days is: “the bear case sounds smarter.”
It’s true that outlandish predictions about negative outcomes often sound better-informed to people not familiar with the complexities of finance or economics. But just because prognostications of doom sound “smart” to laypeople doesn’t mean they are helpful.
Before we can dive into the details of why the bear case sounds smart, it’s important to set the terms of debate: bearish predictions have been absolutely, catastrophically, and indisputablywrongfor a decade running.
Back in November, the team at JP Morgan Asset Managementpublisheda chart filled with negative predictions made by some of the most widely-quoted prognosticators associated with the financial industry.
The chart makes it clear: if you had listened to the bears over the last decade your account would be worth a lot less today than it would otherwise.
JPMorgan Asset Management
Of course, the wrongness in recent history doesn’t rule out bad things happening to financial markets at some point. They absolutely will, and that’s how markets aresupposedto work!
But the “smarter” bear case has been a disaster for investors that heed it too closely.
So why do so many people — even some financial markets professionals — fall for it?
There are 5 clear reasons.
The bear case sounds confident
There’s a reason that hucksters and scammers have historically been called “confidence men” or “con men.” Convincing people that something which lacks compelling evidence is true requires signalling to an audience that it can’tpossiblybe any other way.
Be very cautious of any prognostication about markets which start with someone claiming something “will” happen or a market drop is “assured.”
These sorts of certainties are a classic sign that someone is trying to mislead. That’s especially true if when challenged, the forecaster can’t openly admit potential flaws in their thesis.
Especially for someone outside a given discipline, it’s an entirely natural inclination to believe that a supposed “expert” who is talking about something complicated in a confident manner is well-informed. But sounding well-informed and being well-informed are definitely not the same thing!
The bear case uses jargon
The financial industry and economics discipline – like their peers – are filled with jargon. Just as lawyers deploy a blizzard of briefs, motions, appeals, pleadings, or injunctions, economists and financial markets professionals talk about a specific set of obscure systems using complex vocabulary.
For someone not familiar with the financial markets, it’s very easy to hear a few pieces of unfamiliar vocabulary and assume they’re being used correctly. There’s nothing wrong with a person who has expertise elsewhere not knowing how to interpret financial jargon, but that gap in understanding opens a door to being deceived.
Of course, some people who have a negative view of the markets are well informed in a specific area or maybe many areas, just as many people with a positive view of markets are poorly informed. Unfortunately, for a non-expert, jargon often makes the conclusions impenetrable. .
The bear case assumes positive, not negative, feedback loops
There aren’t many systems in nature or the realm of human endeavors where one thing going wrong makes other things go wrong. If that happens, small negatives can very quickly grow exponentially, turning into catastrophes. A nuclear meltdown, where the speed and intensity of fission accelerates rapidly, is one example of a system where initial problems cascade in this way.
For most systems, though, there are limits or feedbacks that limit events from running out of control. For instance, a forest fire eventually runs out of fuel it depends on to burn.
Most systems are a complex balance of factors which make initial problems worse, and factors which work counter to the initial problems and prevent disasters from spreading. In fields related to mass human behavior, like economics, figuring out the balance can be quite challenging.
A classic fallacy of the bear case is to assume that negative outcomes bring more negative outcomes with them, in a spiraling series of poor result.
Policymakers or private market functions often make mountains into mole hills because they have the tools to contain to shocks. For instance, the Federal Reserve and other central banks can react to weak economic or market data by easing policy or signaling a more dovish stance. This helps to cut off a potential economic mess.
So while those disastrous feedback loops do exist, it’s critical to question why they are relevant to a given scenario and not already working their ills. Further, that sort of mental framework has to explicitly justify why the downturn won’t trigger a response that would reverse an initial shock.
The bear case is conspiratorial
Humans love a good conspiracy.
Doomsaying prognosticators know this and often rely on it, offering animistic explanations which purport to reveal a greater truth. Colorful language describing abeast,porcupine,orzombie, or calling monetary policymakers associal engineers: this is the language of conspiracy, and it suggests the Federal Reserve (or any other group whose market function isn’t fully understood) is some sort of secret cabal, just like the cabal (or maybe even the same one!) that shot Huey Long, assassinated Kennedy, and faked the moon landing.
The bear case ignores fact
“This time is different” is a sarcastic response offered to most objections about the historical precedents used in the bear case over the years. Unfortunately for all of us, historical analogues have to be imperfect; there’s no such thing as exactly repeated circumstance.
And it’s the differences which make, well, all the difference. One excellent example is how long and enduring this economic expansion has been. Small shocks which in the past might have been enough to send an overheated economy wobbling into recession have been shrugged off time and time again despite claims that each would bring a collapse.
The reason is simple: the economy has never managed to over-invest, over-borrow, or over-spend enough to be at risk of recession in this cycle. It’s pretty hard to trip and fall flat on your face when you’re walking cautiously rather than sprinting.
In the chart below, I show the history of US debt-to-GDP by macroeconomic sector. As shown, since peaking at 370.6% of GDP in Q2 2009, debt has been slowly declining relative to output. That process of deleveraging without further recessions is what Bridgewater Associates founder Ray Daliocallsa “beautiful deleveraging”: persistent economic growth helping to reduce debt burdens over time without a sudden stop in lending.
The process of a beautiful deleveraging is unique in post-World War II US economic history. But bears have consistently ignored this crucial, simple analytical building block for the current state of the economy because of a refusal to admit that sometimes “it really is different.”
Eventually the bear case will be right
At some point, bad things happen. That’s the way of the world, in financial markets or elsewhere, and it’s inevitable. But as the original chart at the top of this column showed, beingeventuallyright is cold comfort if you’ve been badly wrong for a long stretch of time. Avoiding the logical pitfalls and deceptive framing of the bear case can help investors pick out when it’s most likely to be right even if it’s been wrong for a long time.
The bear case sounds smarter because it is confident, filled with jargon, forecasts cascading negative events without any intervening positive ones, uses conspiratorial reasoning, and ignores inconvenient facts.
But remember, these are rhetorical strategies andsoundingsmarter does not meanbeingsmarter.