The world is complex, but the human mind seems to prefer simplicity, even at the expense of accuracy.
2021 did not feel so uncertain. Who was able to predict in 2021 that we were about to experience the worst opening 6-months for 40 years in the equity markets? That both bonds and equities would print double digit drawdowns for the first time in 40 years with the worst inflation since 1981.
Hindsight bias make us believe that we anticipated what just occurred, when the truth is, we had no idea what was about to happen. We also have the inherent tendency to create a storyline (narrative fallacy) to explain what is happening.
“Our brains constantly create narratives to make sense of the world around us. The narratives we desire fuel our interest in predictions. Meanwhile, our memories morph with each passing day, much like the distortion that occurs when children play “telephone” — the message mutating a little bit each time one person whispers it to the next.” – Peter Lazaroff
Our flawed, incomplete memories of past predictions keep us coming back for more. Old predictions are old news. We move on and forget. Professional experts know that there’s no demand for accountability. People just want a story that helps make sense of the world around them. We know the future to be uncertain, but a false sense of certainty is preferred to no certainty at all.
We like to believe that the world is ordered, and we discount the role played by randomness. When we succeed, we never acknowledge the role of luck. Its only that we don’t succeed that we attribute outcomes to bad luck. This is a failure of common sense.
Everything is Obvious: *Once you know the Answer
This is the title of a brilliant book by author Duncan J. Watts. He suggests that our “common sense” isn’t so special and can often lead us down wrong paths. The book is about how human reasoning is flawed.
“Common sense explanations therefore seem to tell us why something happened, when in fact all they’re doing is describing what happened.” – Duncan J. Watts
For every hard question there is a common sense answer that’s simple, seductive, and spectacularly wrong. It creates an army of pseudo experts with strong, but misplaced opinions. Watts suggest that the paradox of common sense, therefore, is that even as it helps us to make sense of the world it can actively undermine our ability to understand it.
Common sense was more suited to making rapid decisions to avoid predators rather than rational choices where we must consider vast quantities of information. We love to interpret history into one clear story leading to a predestined outcome. The truth is that the past is a collection of individual paths, any of which could have become the dominant storyline.
When we look to the future everything is uncertain. Looking back in history everything seems inevitable and obvious. The future presents various possible outcomes, but history seems to be an obvious linear progression. Things that we did not know at the time seem obvious in hindsight. History conspires to mislead us into believing we understand more about the world of human behaviour than we do; and in turn, why attempts to predict, manage, or manipulate social and economic systems so often go awry.
We consider rocket science to be complex and hard. Problems having to do with people and human behaviour seems like it ought to be just a matter of common sense. The sad fact is that we are better at planning the flight path of an interplanetary rocket than we are at managing the economy, understanding, predicting, or responding to the behaviour of people.
When something happens, we instinctively look for explanations. What appears to us to be causal explanations are in fact just stories – descriptions of what happened that tell us little about the mechanisms at work. Because these stories have the form of causal explanations, we treat them as if they have predictive powers. This in turn leads to our own deception that we “actually knew” or that should have known.
Many of the conclusions that we make that seem obvious in retrospect could not have been distinguished from other equally likely possibilities before it happened. Historical outcomes that we take for granted were highly contingent and not easily predictable beforehand. Everything feels obvious with the benefit of hindsight.
We rationalize everything we do, past and present. We engage in selective perception, seeing only the things that agree with us. In short, we create a reality construct that bear only passing resemblance to the objective universe.
The winning narrative was always obvious……
Sometime in 2024, we will look back at the second half of this year with bemused detachment. The outcome of the debate between bear market rallies and inflation-caused-recessions will likely have already been resolved by then. We will wonder how such an obvious conclusion was missed in real-time by today’s investors. Only they couldn’t because it wasn’t. -Barry Ritholz
Hindsight Bias causes us to perceive past events as having been more predictable than they actually were. This “knew-it-all-along” phenomenon (common sense after the fact) actively undermines our ability to make better decisions about the future.
Awareness of this human foible could help us to learn from rather than rationalise our past failures.
The above article was written by Marius Kilian.
*Duncan J Watts, “Everything is Obvious: *Once You Know the Answer (How Common Sense Fails Us)”
*Duncan Watts, newscientist.com, “Un-common sense”
*Peter Lazarof, peterlazaroff.com, “Why Expert Predictions Are Bullsh*t”
*Barry Ritholz, ritholz.com, “Lessons from the Future”
*William Koehrsen, williamkoehrsen.medium.com, “The Failures of Common-Sense”