Ezra Klein’s recent interview with uber-economist Ken Rogoff included the following interesting exchange:
You said that there are indicators we can watch to predict when we’re vulnerable to a financial crisis, but in general, the problem is that policymakers explain the indicators away. Information, in other words, is not enough, because people create stories to explain the information away.
Start with a really important point: It’s very hard to call the timing of a crisis. You can see that an economy is vulnerable, and maybe even fairly reliably say you’ll have a crisis in 5 to10 years, but until it’s upon you, it’s hard to narrow the window down with any precision. Many of the people who say they predicted the crisis in a precise way had actually been predicting a crisis for years. There’s irreducible uncertainty coming from fragile confidence and political factors. The analogy is someone who’s vulnerable to a heart attack. You can go to the doctor and they can see your cholesterol is high and you have a number of risk factors, but you might go on for 20 years without anything happening. Or it might be 20 hours.
Because the timing is hard to call, policymakers have trouble getting seized by it. Why worry if it is not going to hit on my watch? And if you’re an investor and you’re making great money for five more years and then you have a bad year, you still have a good decade. But policymakers, especially, need to have a longer vision because of the human cost of financial crises, particularly in the hugely elevated level of long-term unemployment.
Investing is always disconcerting because of the real and perceived risks to the capital markets and to the global economy. Professor Rogoff’s point about timing a financial crisis based on known fundamental data is an important one. Risks may be in place to cause a crisis, but if the likely window of time for those risks to actually result in crisis range from the next couple months to the next several decades the investor is left with the decision of how to incorporate those known risks into an investment plan. It is one thing to be aware of great fundamental risks and it is another to be able to translate that knowledge into profitable investment returns.
Again, we see why pragmatists gravitate to tactical asset allocation. The tactical asset allocator accepts the reality that timing market moves based on fundamental data is nearly impossible. Therefore, the tactical asset allocator embraces the concept of reacting to trends in a disciplined fashion. It is the next best thing to having a crystal ball.
