I occasionally make fun of investing and finance news.  Here and here are a couple of good examples.  Most investing news plays to our greed and fear, the two most common emotional challenges to successful investing.  But some news presents logical-sounding investment ideas, which typically come from professional investor interviews, books, or research papers.  The problem is that you can always find another professional who will disagree with any given investing idea.

Here’s a good example of diametrically opposed investing ideas published on the same day at the same finance news website:

• Five reasons emerging-markets stocks could outperform U.S. stocks for several years
• Stock investors are falling in love with emerging markets–here’s why that might be a problem

The first article makes the following case for investing in emerging markets:

• Emerging-market stocks have historically outperformed U.S. stocks during end-of-cycle periods like the current one*
• Standard value metrics like price/earnings and price/book ratios indicate emerging-market stocks are cheap compared to U.S. stocks
• Emerging-market economies have been growing faster than the U.S. economy
• The Fed’s recent pause in interest rate hikes should weaken the dollar, which often favors foreign markets
• The inevitable resolution of the trade war between the U.S. and China should ease existing concerns about emerging markets.

That all sounds pretty convincing!

But the second article argues that the emerging-market thesis is common knowledge, which means the markets could move in the opposite of the expected direction.  This reverse-psychology view is called “contrarian investing”, and it’s been around nearly as long as the stock market itself.  Contrarians try to zig when everyone else thinks it’s time to zag.  The article notes that purchases of emerging-market funds have reached their highest level since 2010, which implies emerging markets are conventional wisdom that’s best avoided.

The clash of conventional wisdom and contrarian investing applies to almost any investing thesis.  And many times it’s hard to tell which idea is conventional and which is contrarian.  Almost everybody feels that their view is uniquely perceptive, but groupthink (or the “bandwagon effect”) is a difficult cognitive bias to avoid.  If you’re not jumping on the conventional wisdom bandwagon, there’s a seat waiting for you on the contrarian bandwagon.  And what about reverse reverse-psychology?  Because contrarian investing is such a long-standing and popular concept, couldn’t the contrarian view on any given investing idea actually be conventional wisdom in disguise?

Hindsight and Foresight

Emerging-market stocks have looked cheap and their economies have grown relatively quickly for many years now, and yet the expected superior performance hasn’t materialized.  It feels like the news has been trumpeting the coming boom in emerging-market stocks since at least 2015.

The difficulty of timing an investing idea can be illustrated with a simple thought experiment.  Let’s suppose it’s late 2014, and the news is full of quotes from professionals like, “There’s so much more capacity for growth in these [emerging] markets.”  So, you work up your courage and invest in an emerging-market index fund at the start of 2015.  Here’s how a $1000 investment in emerging-market stocks (red line) performed as compared to U.S. large caps (blue line) over the rest of 2015, according to Portfolio Visualizer.

Ouch!  Your emerging market fund return was -15% while U.S. large caps returned 1%.  But what if you had instead decided to wait a year before investing that $1000 in emerging markets?  Here’s the same comparison for 2016 (again, emerging markets are the red line).

That worked out better for you, but that emerging-market fund still didn’t leap ahead of U.S. stocks.  Maybe the third time’s the charm.  Here’s the result if you had waited until 2017 to pull the trigger on that emerging market idea.

 

In 2017, emerging-market stocks returned a whopping 31%, while U.S. large caps returned an also-pretty-great 22%.   It only took three years for the superior performance of emerging markets to show up!  This thought experiment shows that the result of a good idea with the wrong timing is often indistinguishable from a bad idea.  To drive the point home, let’s look at the entire time that emerging markets (red line again) have been promoted as a “great” investing idea, which extends from around 2015 through April 2019.

The annualized return in this period was 4.3% for emerging markets and 10.7% for U.S. large caps.  And even if you were lucky enough to buy emerging-market stocks right before that surge of performance in 2017 and held them through today, the annualized return was only 10.8% for emerging markets as compared to 14.6% for U.S. large caps.  In fact, the emerging-market thesis only worked if you guessed right both on the time to buy (start of 2017) and the time to sell (end of 2017).  Almost any other timing in this period would have resulted in worse performance than simply holding something boring like an S&P 500 index fund.

We’re “Overdue”

Unfortunately, many people take the wrong lesson from these historical examples.  Instead of concluding that investing in the newest shiny idea is a long shot, they conclude that the idea must be “overdue” for a winning streak.  Of course, this is just the cognitive bias known as the Gambler’s Fallacy at work.  Just because flipping a coin gave you heads five times in a row, you still have a 50 percent chance of getting tales in the next coin flip.

History has shown time and again that shopping around for new investing ideas from the media, “experts”, a salesperson, your friends, or any other source is a distraction to successful long-term investing.  Pick almost any investing idea from 5 years ago, and chances are that either the idea or the timing turned out mostly wrong in the end.  For example, five years ago many professionals were expecting that value, small cap, health care, and real estate stocks would be the smartest plays.  But in fact, boring old U.S. large-cap stocks have outperformed all these ideas since the start of 2015, as shown in this table based on Portfolio Visualizer total return data.

Stock Type	Annualized Return (CAGR)	Volatility (St. Dev.)	Max Draw Down
U.S. Large Cap	10.7%	11.8%	-13.6%
U.S. Large Value	9.2%	11.5%	-11.0%
U.S. Small Cap	8.8%	14.7%	-19.6%
U.S. REITs	5.8%	14.6%	-15.0%
U.S. Health Care	8.4%	14.3%	-15.7%

And except for value stocks, these “smart plays” also experienced higher volatility and deeper drawdowns than U.S. large-cap stocks.  It turns out that the professionals are pretty dismal bargain hunters.

Perhaps emerging markets, value stocks, small caps, or something else will sky-rocket next year or the year after.  But there’s no way to know for sure.  Rather than shopping around for new goodies to put into your portfolio, mindful investing is about picking a reasonably diversified asset allocation and sticking with it for the long term (at least 10 years).  That’s no guarantee that all your assets choices will be champs.  But you’ll avoid crippling mistakes that often come with trying to pick and correctly time the investing idea du jour.  In fact, mindful diversification means that you’re guaranteed to have at least one asset that’s always dragging down your portfolio’s performance because there will always be another asset that’s the best performer in your portfolio.

When You Assume…

Beyond the uncertainty and market-timing problems inherent with any hyped investing idea, they also usually involve assumptions about current causes and future effects.  More often than not, these assumptions are hidden.  Let’s look at the five main points from the article recommending emerging-markets, which I summarized at the outset.  But this time, I’ll explicitly frame some of the assumptions implied by the author and his sources:

• Because emerging-market stocks have sometimes outperformed U.S. stocks at the end of past economic cycles, they assume this will happen again.  They further assume that the economy will cycle into a recession soon.  Both assumptions could turn out to be wrong.
• They assume that cheap emerging-market stocks will catch up to U.S. valuations.  Why couldn’t U.S. stock valuations sink to emerging-market levels instead?  And emerging-market stocks have been cheap compared to U.S. stocks for most of the last 15 years.  Why can’t that trend continue for another 15 years?
• They assume that emerging-market economies will continue to grow faster than the U.S. economy.  A global recession could easily reverse this pattern.  And why haven’t the last five years of faster growth boosted emerging-market stocks already?
• They assume the Fed will continue to be patient with interest rate hikes, that slower rate hikes will weaken the dollar, and that the weakening dollar will boost emerging markets.  That chain of assumptions could break at any link.  The Fed unexpectedly reversed its interest rate stance in early 2019, and it could just as easily reverse course again.  And slower rate hikes haven’t always weakened the dollar and helped emerging markets in the past.
• They assume the trade war between the U.S. and China will soon be successfully resolved.  Just two months after this article was written, trade negotiations are floundering and the war is escalating.

And the contrarian article contains assumptions as well.  For example, more people investing in emerging markets could mean that this particular trade is overplayed, or it could mean that many more investors will follow the herd into emerging markets.  And more buyers would likely boost emerging-market stocks and prove the contrarian’s wrong.

Conclusions

It’s easy to become distracted by the next shiny new investing idea.  In our consumer society, advertising constantly trains us to think that newer is better, products are always improving, and old things are worn out, even if they’re still functional.  But if you stop and think about your shopping experiences, advertising rarely describes reality.  After trying a new product, we often find we prefer the same old product we’ve always used.  The new box splashed with the word “improved” often turns out to contain something nearly identical to our last purchase.  A piece of plastic breaks off that really cool-looking new gadget a week after we bought it, while the old gadget is still working fine.

Real innovation in the investing industry is slow to evolve.  By the time a new idea becomes proven** (for example, index investing is better than actively picking individual stocks) it’s too boring for the daily news headlines.  Instead, it’s buried deep in the text as a brief given, or an aside to help less knowledgeable readers follow the article.  And of course, most new investing ideas are never proven, or the short-term trends they try to exploit evaporate.

So, you can treat most new investing ideas as mere advertising for one side of the argument.  Even if you can’t find news articles on both sides of the argument, rest assured that some “expert” somewhere firmly believes in the counter-argument.  The debate may take the form of conventional wisdom versus contrarian views, or it may hinge on some other dichotomy.  But regardless, both sides of the argument will usually involve:

• A prediction that could easily turn out to be just plain wrong
• One or more entirely disputable market-timing decisions
• Multiple supporting assumptions, any one of which could prove false.

I’ll go out on a limb and say that no new investing idea is actionable.  But that’s not because we’ve learned everything there is to know about investing.  Certainly, a few new ideas may evolve into proven investing concepts over time.  The problem is, it’s impossible to tell in advance which ones are passing noisy advertisements and which ones will still quietly ring true decades from now.

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* The economy typically cycles through periods of growth and recession.  Recessions have occurred about every 5 years on average since 1945.  Because the economy has been growing since the last recession in 2008, many people think we’re near the end of the current growth cycle. 

** Markets, economies, and societies change over time.  So, even the “proven” ideas can and often do become outmoded after enough time has passed.