by Steven Visscher, Mawer Investment Management
Recency Bias – the tendency to use our recent experience as the baseline for what will likely happen in the future, despite historical information that argues to the contrary.
As humans, we often invent a skewed view of reality by overemphasizing recent events. Even if we don’t intend to, it’s natural to allow past information to fade and allow newer information to garner more attention.
Investors do this too. One of the more memorable examples comes from examining equity returns across different regions of the world. When we look at very long-term returns (i.e. 50+ years), there is not a dramatic difference between equity returns across regions. But they can vary much more so in shorter timeframes.
During the 1990s, the S&P 500 (C$) had an average annual return of 20.8%. What a decade! In this same time period, Canada’s TSX index earned only 10.6%. After seeing this decade of U.S. outperformance, many investors fell prey to recency bias and shifted their investments more heavily into the U.S. market. But 10 years later they were in for a serious disappointment because in that decade, it was Canada that led the way with an average annual return of 5.6% while the S&P 500 (C$) lost 4.1% per year.
We believe some investors are now making this same behavioural error again. With the memory of Canada’s recent market dominance fresh in our minds, it’s easy to forget about the 1990s when Canada lagged. And there appears to be several reasons why Canada’s good fortune could continue. For example, Canada has a much healthier fiscal situation than the U.S. or Europe. Their debts have been downgraded while we remain one of the few countries to boast a AAA credit rating. We have fewer unemployed, a stronger banking sector, a more stable political and regulatory framework, and an abundance of commodities that the rest of the world craves. Canada’s markets must be reining supreme right? Not so fast.
In 2011, Canada’s S&P/TSX lost 8.7% while U.S. equities gained 4.4%. Thus far in 2012, Canada continues to lag. Our S&P/TSX has gained approximately 2%, while U.S. equities have gained approximately 10%. Even Europe, amidst all of its challenges, has gained over 5% so far in 2012. So much for all our advantages noted above. This may be happening because markets are forward looking beasts, and if a drawn-out global economic slowdown were to occur due to difficulties in China, Europe and the US, then Canada and its commodity sensitive economy may suffer more than these other economies. But our point is not to try to analyze the future – it is to caution about the shortcomings of the human mind.
As investors it’s easy to fall into the recency bias trap. To help avoid this pitfall, it’s important to take a long-term view, stay disciplined, stay diversified, and don’t forget the past.
Steven Visscher
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