mine read on friday includes a chart Shows “where Americans get their news from and who they trust to get their information.” Interestingly the obvious proponents — Breitbart, Fox News, and MSNBC — are least trusted. But it’s also interesting to see how many people trust media sources that are considered more objective, such as PBS, the BBC, and the top-ranked Weather Channel.

I am surprised by some of them push back TWC and general weather forecasters. It’s a probabilistic exercise, but has improved objectively over the past few decades, especially when it comes to extreme risk events. In any case, this gives us an opportunity to discuss a particular form of bias: the tendency to exaggerate low-probability, negative outcomes.

I suspect that people are more likely to intuitively grasp the downsides of things than the upsides. Risk aversion is well known – imagine the survivability of those who routinely ignore existential threats to themselves versus those who do not. We imagine that the adventurous subgroup has their genes drop out of the pool because – oops! – Self-inflicted death and those who do not ignore the risks.¹

This discussion led me to look for a chart (above) that I recalled from (then LPL) Jeff Kleintop. It shows some of the more popular “threats” to the market that will derail the bull market. I’ll quickly add that the S&P 500 is down 67% — about 1,500 then, and about 4,500 today.

Kleintop points to a Texas A&M study that found that when the Weather Channel predicted a 20 percent chance of precipitation on the same day, the chance of precipitation was only 5.5 percent.

Lessons for us: “Weather forecasters have been known to exaggerate fears of negative, low-probability outcomes (such as the likelihood and amount of snowfall), and this bias is also frequently seen in forecasts for non-weather-related issues. “

Applying this to the worries of the average investor is not an easy task: recessions, wars, interest rate hikes, currency problems, social collapse, even a nuclear apocalypse.

This is not to say that we should ignore the “unknown unknowns”; rather, we should recognize that black swan events are extremely rare. Even negative cyclical events — far less rare but still rare — tend to be exaggerated.

This is relevant because the headlines today are mostly recessionary chatter, structural inflation, and even stagflation fears. These are negative, low-probability, high-impact events; Kleintoop cites research showing that we tend to overestimate how likely they are to happen. As a result, they get a disproportionate amount of media coverage and tend to occupy a place in investors’ minds.

The detrimental effect of these exaggerated forecasts on investor psychology is yet another reminder that forecasting is worse than wasting investor time.

Before:
War has less impact on stocks than you might think (March 2, 2022)

How We Experience Time, Inflation Edition (November 10, 2021)

Misunderstood Narrative: A Hero’s Journey (September 22, 2021)

What if everything was narrative? (21 June 2021)

see also:
There is always a reason to sell (BatnickJune 10, 2020)

source:
Negative, low-probability outcomes have been exaggerated
By Jeff Claytop,
LPL FinanceNovember 30, 2013
https://bit.ly/35UEUPJ

Updated: April 11, 2022 at 5:38 pm

The original article is no longer posted on LPL, but a mirror of Jeff Kleintop’s comment is on Business Insider: Negative, low-probability outcomes have been exaggerated.

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1. We could easily create an opposite scenario: a group of risk-averse cavemen who don’t want to attack a mammoth might starve that winter, and the next cave that tries and succeeds has meat and fur to get them through the winter. Of course, risk-embracing groups lost some members in the attack, but the community as a whole did better.

Narrative fallacies are easy to overlook when making these stories assume certain prior events. We should always be aware of this when we create stories that explain evolutionary psychology…