Let’s turn the clocks back a little over a year. Going into 2025, the consensus view on markets was:
- U.S. Exceptionalism: The U.S. is the only equity game in town. Europe and the rest of the world had fallen behind on AI and tech innovation.
- Lower Rates: Investors expected rate cuts and, by extension, much lower interest rates in the near future.
- The End of Inflation: The battle against inflation had been won and price stability was a guarantee.
Unfortunately, all three of these things didn’t turn out as planned. Over the last year, U.S. stocks underperformed international stocks, rates dropped less than expected, and inflation proved to be stickier (and higher) than we realized.
Of course, things don’t always go according to plan. But when we make major financial decisions based on the consensus view, they can backfire. As Mark Twain once said:
It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
Why does this happen? Why does the consensus view fail more often than we might expect?
Why Does the Consensus View Fail?
There are a few key reasons why markets sometimes get it wrong:
- Recency Bias: We think the future will be like the recent past. When U.S. stocks dominated on the global stage in 2024, many investors believed the same would continue into 2025. As a result, U.S. stocks were bid up and priced for more of the same. Unfortunately, things didn’t play out that way and U.S. stocks struggled relative to international stocks. The problem with thinking the future will be like the recent past is that it skews the risk-reward tradeoff. When everyone expects the status quo, assets are priced to reflect that. Therefore, any deviation from those expectations can cause investors to rush for the exits.
- Chaos Theory: We can imagine the future all we want, but no amount of mental simulation will ever compete with the randomness of nature. As chaos theory has demonstrated, even simple systems with simple rules will behave in unpredictable ways. Now imagine what happens with complex systems with complex rules. Morgan Housel said it best:
“We are very good at predicting the future, except for the surprises—which tend to be all that matter.”
And these surprises can lead to the most unlikely of outcomes. For example, who thought that gold would soar and Bitcoin would falter with rising geopolitical tensions? Not me. But that’s exactly what’s happened this year. I thought Bitcoin was “digital gold,” but that doesn’t look to be the case anymore. I was surprised by some things that transpired recently and it’s changed my view on the asset class.
I won’t say much more other than I have a stop loss set at a much lower price. If it triggers, I’m out. It was good while it lasted, but I no longer need this asset class to reach my financial goals.
- The Stability Illusion: The reason the consensus view sometimes fails is because it’s often right. The world typically changes slowly. So betting on the world not changing can be a profitable strategy. For example, there was a trader on Polymarket (the event prediction market) who bet “No” on almost everything and made $2M in profit. If you believe that “nothing ever happens,” you’re usually right. However, this can create a false sense of security. Because when we bet on stability, it’s easy to get blindsided by instability. As Vladimir Lenin once said:
There are decades where nothing happens and weeks where decades happen.
Whether it’s recency, chaos, or the illusion of stability, the consensus view fails more often than we think. So, what’s the solution?
The Antidote to Certainty
Given that the consensus view can be wrong, here are some ways to counteract this uncertainty in your financial life:
- Diversification: I know how cliché this sounds, but diversification is something you should practice both inside and outside of your portfolio. I’ve paid the price for owning international stocks for years, but for the first time since 2012, my portfolio is outperforming the S&P 500. This is the upside of diversification I’ve been waiting for. Outside of your portfolio, you should try and make diversified financial decisions as well. If you are convinced that rates will drop in the next year, don’t bet big on such an outcome. We all know someone who took out a variable rate mortgage because they were “certain” that rates would drop. Well, they are feeling the pain now that they can’t refinance as planned. You can diversify across time, across geographies, within your career, and much more. The key is to spread out risk so that no single decision is a point of failure.
- Anti-Optimization: Instead of trying to predict the future based on what the market thinks, be okay with suboptimal outcomes. I’ve previously argued that you shouldn’t try to optimize your life, and I believe this applies here as well. When someone makes an all-or-nothing financial decision, they are trying to create an optimal outcome. They are trying to avoid leaving money on the table. This is completely natural, but it can also drive you mad. If you’re an optimizer, it’s easy to always be second-guessing yourself. But that’s no way to go through life. The better approach is to accept that you won’t make the best choice and let the chips fall where they may. This doesn’t mean to be stupid about your decisions, but don’t obsess over them either. When you admit that you don’t know the future, it’s a lot easier to deal with it when it doesn’t go as planned.
Ultimately, the only antidote to certainty is to embrace uncertainty. It’s to prepare for a future that we can’t yet imagine. We do this through diversification and accepting that we won’t always get it right. After all, these are the only things we can control.
If you do this right, you won’t be alarmed when the consensus view turns out to be wrong. Because you planned for things to not go according to plan all along.
Thank you for reading!
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This is post 489. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data