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DOUG  By Guest Blogger Doug Rowat
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Anyone remember Alexandre Daigle?

Daigle was a ‘sure thing’ future NHL offensive superstar when he was selected first overall by the Ottawa Senators at the 1993 NHL draft. He went on, of course, to become a spectacular bust, scoring only 129 goals in 616 NHL games with perhaps his most noteworthy career highlight occurring off the ice when he was thrown off a team flight for joking about an on-board bomb.

It’s easy to laugh at the Senators now and conclude that Daigle was an obvious poor selection, especially given that three of the remaining four picks rounding out the top five that year went on to become Hall of Famers. But the key word here is “obvious” and this is the mistake almost everyone makes, especially investors, when looking back at history. Most outcomes only seem obvious in hindsight.

  In 1993, there was nothing obvious about Daigle’s eventual failure. Daigle lit up the Quebec Major Junior Hockey League, including scoring 137 points (with a league-leading 2.58 points per game) in his final full season. To put this in perspective, this year’s almost-certain #1 pick (the NHL draft goes next week) and the latest ‘sure thing’ prospect, Alexis Lafreniere, led the QMJHL this year with only 112 points (2.15 points per game). Daigle also played brilliantly amongst the best players in the world in his age group at the World Junior Championships, winning a gold medal the same year that he was drafted.

And, generally speaking, taking the most-hyped player in any draft year is a pretty safe bet. Consider the #1 draft picks from 2005 to 2015 (I exclude more recent #1s because they haven’t had enough time to prove themselves): the list includes eight probable Hall of Famers, including Sidney Crosby, Patrick Kane and Connor McDavid. In other words, for many reasons, the Senators picking Daigle first overall was a reasonable decision.

But this is what’s at the core of hindsight bias: overlooking the sound rationale behind an ultimately mistaken decision and presuming that the better decision (in this case, selecting someone besides Daigle) was unambiguous. But looking back smugly after the fact and declaring that the eventual results were “obvious” can lead to poor and overconfident decisions in the future. Psychology Today sums up the cost of hindsight bias best:

You rewrite history, so to speak, and revise the probability in hindsight. Going forward, you use that new, higher probability to make future decisions. When, in fact, the probabilities haven’t changed at all. Hindsight bias can make you overconfident. Because you think you predicted past events, you’re inclined to think you can see future events coming. You bet too much on the outcome…and you make decisions, often poor ones, based on this faulty level of confidence.

Now, let’s bring this all back to investing. You might remember 2015? Seems like a simpler time compared to 2020, but if you recall it was a rough year for the Canadian equity market. The S&P/TSX Composite dropped more than 8% that year and significantly underperformed the S&P 500, which actually managed a modest gain. Starting in the spring of 2015, the TSX also had a short-lived, but still unpleasant, 15% correction.

A former client emailed me near the end of 2015 and stated that the correction in the S&P/TSX Composite “was pretty much announced” and that I should have easily anticipated it. I responded bluntly that corrections tend to be of short duration and we’ll never be able to dodge these pullbacks on a consistent basis. In short, I stated that we manage investments for the long term.

I also highlighted many of the sudden and unexpected events that caused the correction, including a slowdown in China growth, which took the WTI oil price down almost 40% in a span of only 52 days (and helped plunge Canada into a mild recession), confusing Fed interest-rate-policy guidance that roiled markets (recall that Janet Yellen was still learning the ropes back then) and two Bank of Canada rate cuts, the first of which not one analyst on the Street was forecasting. To make matters worse, this client was also arguing that I should have had most of his money in the S&P 500 at the start of the year—the index that, of course, performed better. In other words, he suggested that I should have put most of his eggs in one basket.

When you work in the investment industry long enough, you realize that nothing is “pretty much announced” and nothing is obvious. Commenters on this blog regularly imply that they’ve predicted past market shakeups long before they occurred, Covid-19 being a recent example. But, of course, no one (well, maybe Bill Gates) was predicting a global pandemic in 2019. A pandemic only seems foreseeable now because we’re currently living through one. But cue the hindsight bias: there’s suddenly no shortage of bold and confident predictions about what happens next with Covid-19.

More interesting still are all the investment firms that meet with me regularly to make sales pitches and claim that their firm saw the 2008-09 financial crisis coming and took steps to avoid it early. With all these correct predictions of the financial crisis it’s amazing that it occurred at all.

Investors need to recognize that forecasting is enormously complex and resist the urge to assume that what has already occurred was easily foreseen. It was not. And this is why every portfolio should be well diversified.

Now we’ll have to wait a year for the results, but through a simple exercise we can confirm not only the near impossibility of precise forecasting, but also help to diminish the ill effects of hindsight bias by relieving you of some of your investing overconfidence.

Okay, blog dogs, this is your challenge:

Let’s take three major indices: The STOXX Europe 600, the Nasdaq and the S&P/TSX Composite. For each, estimate their percentage gains over the next year. Secondly, rank them in order, best to worst. And finally, because these outcomes seem so “obvious”, assume that you will put all of your available funds into only the ONE index that you believe will do best. Write your forecasts into the comments like so (in whatever order you believe is correct):

1. Nasdaq: XX%
2. S&P/TSX Composite: XX%
3. STOXX Europe 600: XX%

You may feel confident at present with your forecasts; however, this confidence is unlikely to last.

A year from now it’s a virtual certainty that your percentage gain or loss estimates will be off wildly, it’ll be unlikely that you’ll have ranked all three indices correctly and also probable that you’ll have paid a price by concentrating your eggs in one basket. You may not even end up getting the overall direction of the three markets correct (e.g., the indices ended up declining when you were forecasting a gain).

But don’t take my word for it. We can all check back a year from now and see how you did. You can tell me then whether or not I was correct in my assertion that forecasting is incredibly difficult.

And, while we’re waiting out that year, let’s cheer for Alexis Lafreniere. I’ve seen him play–he’s an awesome talent. And I hope he has a better time of it in the NHL than Daigle did.

But if he ends up sucking, please, please don’t tell me that you knew it all along.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

 

Save ‘The Last Dance’

DOUG  By Guest Blogger Doug Rowat

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What do they say about mullets? Business in the front, party in the back? Zoom meetings during the Covid-19 lockdown have become the mullets of 2020: suit and tie for the camera, anything goes below the waist.

I have to confess to my clients on Zoom, this is what’s most often going on below my waist:

But avert your eyes for a moment from the Cro-Magnon-man legs and notice the Air Jordans. Not only are they damn comfortable, but like almost everything else that I’ve purchased in my 23 years or so on Bay Street, there’s an investment angle.

The shoes are a retro version of Michael Jordan’s iconic “Bred” Air Jordans, which were famously banned (so the legend goes) by the NBA because they were in violation of its team uniform policy. Most things ‘Michael Jordan’ are good long-term investments anyways, but I was fortunate to own them just prior to the release of Netflix’s epic Chicago Bulls documentary “The Last Dance”. Below is their appreciation on StockX, a benchmark for the US$2 billion sneaker reseller market (possibly on its way to US$6 billion. Guess when the documentary was released?

Air Jordan Retro 1 High OG “Bred”

Source: StockX; chart reflects price movement since 2016 release date (US dollars)

Alas, if only I’d invested in Jordan’s 1986 Fleer rookie cards, which were going for US$40k-$50k prior to the documentary, but now routinely sell for US$75k-$85k in top condition (check out the ‘completed items’ on eBay and see for yourself). Given his enormous and enduring popularity, I doubt that their value’s peaked.

The coronavirus lockdown combined with the insanely popular Jordan documentary may have marked a tipping point for the entire sports card market and I continue to think that, if approached carefully, sports cards make an excellent alternative investment.

Gary Vaynerchuk is a fascinating American entrepreneur. Fascinating not only because he’s successful, having grown his net worth to more than US$150 million, but also because he makes an enormous effort to engage and educate the public through books and social media, and does it without a hint of elitism (sound familiar?). He’s famously said that he gets as excited by a one-dollar garage sale find that he can turn into eight dollars on eBay as he does from a large business deal. He makes the case for sports cards perfectly in this short interview.

What the video doesn’t show is Vaynerchuk’s further recommendation that you spend at least 80 hours thoroughly researching the market before you make even a single purchase. He also notes that concentration risk is a critical consideration—recognize the risks and don’t buy in a quantity that will derail your financial future. Understand also how the risks vary from one type of alternative investment to the next. Vaynerchuk has suggested that comic books, for instance, are lower risk than sports cards—Iron Man will never break a leg, but an athlete might. However, risks aside, an alternative investment should, above all, be fun.

I’ve covered all these points in my previous blog posts:

There’s nothing wrong with having a small allocation (perhaps 2–3%) of your overall portfolio held in something non-traditional.

Perhaps you collect wine, scotch, antiques, vintage cars or motorcycles, artwork, coins or stamps, vinyl records, classic movie posters, sports memorabilia or Star Wars collectibles (check out the Netflix show The Toys that Made Us—a rare Boba Fett action figure can put your kids through university). What’s important is 1) it’s enjoyable and remains so, and 2) you constantly educate yourself and purchase carefully, thus increasing the odds that your collection actually appreciates.

You also need to be fully aware of the risks of your investment. For instance, I know that sports card companies can easily disrupt the market by producing too much product. This is what happened in the mid-1990s when the sports card market was on life support due to oversupply. I’m also fully aware that fraud and counterfeiting are ongoing problems. But this is true of most other investments as well, including art and wine. Witness the collapse of the legendary New York art gallery Knoedler in 2011 or the uncovering of prolific wine fraudster Rudy Kurniawan in 2012.

So, what do I personally collect? Connor McDavid rookie cards…. He’s clearly lived up to the hype. We’ll see if my investment appreciates in 10 years, but it’ll be a lot more fun than investing in, say, a bond ETF. Don’t misinterpret: bond ETFs are crucial long-term investments, but they certainly don’t get the pulse racing.

Investing can be an anxiety-inducing emotional rollercoaster. But the smaller, non-traditional sleeves of your portfolio shouldn’t be this. They should simply be enjoyable.

Just look at that picture with my Air Jordans, my swim trunks and my hairy legs. Do you think I’m not having a great time?

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.