Notes, Views, and the Occasional Provocation January / February 2014 

It was a strange year for the Super Bowl – not just the outcome, but the weather. The Farmer's Almanac predicted a snowstorm for the day of the game, but the players warmed up in shorts on a balmy 50 degrees afternoon, perfect for football. The next day, though, New Jersey was clobbered with single-digit temperatures and piles of snow.

Was the almanac wrong? For purposes of the Super Bowl, yes; if you're a farmer, probably not.

This month's newsletter touches upon predictions, but it's more about what we do when they don't pan out. That's where stories become important, helping reduce the unfathomable complexities of the world's operations into narratives we can digest. Of course, this doesn't make them accurate or even helpful, particularly for our investments.

Best Regards,

Milo Benningfield




The Seeming Inevitability of History
Consensus, surprise, then a sense of inevitability are a familiar pattern when it comes to dealing with failed prognostications, in professional sports as with investing. more



The Seeming Inevitability of History
Thanks to the marketing machine behind the Super Bowl, it felt almost unpatriotic to be heading to the Y for an afternoon swim last Sunday as Seattle and Denver got ready to battle. But, as expected, the pool was empty and quiet, making it the perfect time for some laps.

Afterwards, walking back to my car, I checked the game's score and was shocked: the Seahawks were trouncing the Broncos 29 to 0. But how could I be surprised? I knew virtually nothing about the teams, having lost interest in professional football a couple of decades ago when John Elway was still quarterbacking.

In the two weeks leading up to the game, however, it was almost impossible to avoid the media consensus that favored Denver. Peyton Manning's picture was everywhere, often next to breathless narratives such as this from The Plain Dealer's sportswriter in Cleveland:

The confidence stems from what I – and, I am sure, many others – view as a sizable advantage for Denver at the most important position on the field: quarterback.

Manning is going to excel Sunday . . . . Manning has everything going for him when stacked against [Russell] Wilson: experience, legacy, and a boatload of quality targets. Yes, Manning's talent makes his receivers better, but there is no question Denver's group is far superior to Seattle's. ("Denver Broncos are pick to beat Seattle Seahawks," The Plain Dealer, 02/01/2014)

The Plain Dealer had a lot of company. Fifty-seven percent of the top ninety-three NFL forecasters predicted Denver would win, as did the Las Vegas oddsmakers. Forecasters who favored Seattle did so by only a point or two. No one foresaw the blowout that happened: the final score Seattle 43, Denver 8, one of the most lopsided wins in Super Bowl history.

Afterwards, the narrative began to shift. Terms such as "younger," "hungrier" and "expertly coached" became associated with the Seahawks. With the benefit of hindsight, it seemed inevitable that Seattle would win, and I half-expected The Plain Dealer to turn about and say, "Peyton Manning is a great guy, but you can't beat a whole football team by yourself."

This sports-commentary pattern was familiar. We see the same sequence of media consensus followed by surprise then inevitability whenever market prices move sharply as they did last month.

Going into January, bonds were the underdogs. In 2013, the S&P 500 Index rose more than 32%; small-company and value stocks did even better. Meanwhile, the Barclays Aggregate Bond Index declined 2%. The long-prophesied bond bear market had finally arrived and, according to the consensus, would only get worse as interest rates rose. U.S. Treasury bonds, in particular, were vulnerable after the Federal Reserve's decision to begin decreasing its purchases.

Then January came: the Barclays US Aggregate Bond Index rose 1.5%, and the S&P 500 Index dropped 3.5% in short order. Bonds were suddenly Seattle and stocks Denver, as arguments arose again in favor of holding high-quality government bonds. Investors who had been concerned about a 2% bond decline over the course of last year realized that stocks could lose even more in a week or less.

Now there's a new story about U.S. Treasury bonds: demand for Treasuries by banks subject to new regulations requiring high-quality capital might actually replace demand by the Federal Reserve and other central banks, keeping interest rates low for years.

We saw a similar story reversal with emerging-market stocks. After 2012, when they topped the major stock asset classes with more than an 18% return, we heard about the robust middle classes that were forming in Brazil and China. A year later, after declining 2.6% in 2013 to the bottom of the equity asset stack, we heard how vulnerable emerging-market economies still are to global capital flows.

In the end, these are stories about the short term that is of little consequence to long-term investors. However, it's the short term that gets all the airplay in the media. The stories about the short term skew the longer-term view and undermine investor discipline. This lack of discipline, in turn, is one of the primary causes of poor long-term investment returns.

Some investors try to tune out the day's media stories by focusing on supposedly more objective measures like valuation metrics and leading indicators to measure stocks' prospects. This is a subject for another day, but there's one metric worth mentioning, the Super Bowl indicator.

In the 1970's, a sportswriter named Leonard Koppett discovered a correlation between Super Bowl winners and the stock market's performance with a supposed 80% accuracy. If a team from the premerger NFL won the Super Bowl, markets would rise; if a team from the premerger AFL won, it presaged a bear market.

Some critics suggest that the Super Bowl indicator no longer applies, since the NFC and AFC divisions have been expanding over time, so there are many teams today that were never part of the old NFL or AFL. Others simply group the expansion teams of the AFC with the bears, and the NFC expansion teams with the bulls and carry on with the indicator as before

Even for the indicator's diehards, Seattle's win still raises a question. The Seahawks are the only NFL franchise to change conferences and they've done it twice. They started out in the NFC, then switched to the AFC where they won a couple of division championships before switching back to the NFC, where they play today.

Given all this, what does Seattle's win bode for the markets this year? Even the Super Bowl indicator cannot tell us, to the extent it ever could. But one thing's for sure: we'll know how everything played out by next year's Super Bowl, and by then, 2014's twists and turns will probably all seem inevitable.

Thank you for reading. Please look for our next newsletter in March.

Best regards,

Milo Benningfield

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