Goldfish are famous for only being able to remember about 30 seconds of the past, but recently I have come to believe that investors could give our fishy friends stiff completion. Just look at our latest market selloff. Though the recent fall was quite painful for investors, I would like to point out a simple truth, it wasn’t exceptional. Since 2009 the S&P 500 has fallen 18 times by 5% or more. Twice by more than 10%. Since 2009, that’s just 5 years. This fall was just about 6%. If history holds we can expect another 2 such pullbacks this year alone! In case you believe that this was a rather bad period for the market, I would like to point out that since 2009 the S&P is up over 100%, even after the latest pullback. That’s well in excess of it’s 7,24% average annual growth rate.
Even the selloff in 2008 wasn’t an exceptional, once in a life time event. In fact we get selloffs of comparable size rather frequently, more than once a decade. This is due to a natural human tendency to give undue weighting to the immediate past. You can see this quite clearly on the football field where a few bad games make people question make fans call for a player’s sacking despite the fact that he has been a regular performer.
Nassim Talib turned this observation into a book titled “ Black Swans” . In it he points out that people often give infrequent events much lower probabilities of occurring than are correct. If an event is infrequent enough then we will pretty much assume that it will never occur. That’s the reason that people still live at the foot of Mount Vesuvius 2000 years after the destruction of Pompeii. The volcano is still active and will one day erupt again, destroying the homes of the 600 000 people who live in the blast zone.
In economics the same rule applies. Banks fail, house prices fall and stock markets crash, but if we go through a decade or two without and occurrence, we assume that it will never happen.