Requisite Investor Skills: Think Critically and Accept New Evidence

Critical thinking helps in any field.  I have the pleasure of participating in a discussion list that explores many issues where critical thinking is a focus.  The members have a wide range of ages and specialties.  They are quite different from average people in two respects.  They are intellectuals (an unpopular group in today's society) and they are critical thinkers (an endangered species).

The leader of the group is my own favorite professor.  Anyone who learned and implemented his approach (including reading his most noted book) would be more successful in any field, including investing.  Here is one of his recent challenges to the participants:

Lawyers are often correctly ridiculed as truth facilitators
because they are reason shoppers, i.e., they know in advance what their
conclusion is to be. Then, like a theologian with a closed system who is fully aware that he or she has X as a conclusion, the advocate uses “because” formulations because it sounds right to do so.  Isn’t one supposed to be “reasonable” after all?

This approach to reason stands the standard sequence of “reasons and evidence and the conclusion” on its head.  The result is a revised sequence of cognition or “reverse logic.”  But when I look at the reasoning of those who lampoon the reasonableness of attorneys, I rarely see anything different in their behavior. Scholars tend to have the same individual conclusions decade after decade.

I have even resorted to keeping a museum of intellectual
heroes, including only those people who have changed their minds in public as
scholars when the evidence or their experience took them to a conclusion
contrary to their previous ones.

I added the emphasis to the last paragraph, since I like the museum concept.  I am calling it a personal Hall of Fame.

Investment Implications

Here is the biggest challenge for most investors:

You have an opinion, and you are unwilling to see any new evidence.

Don't feel bad.  According to my professor you are in the good company of both lawyers and scholars.  I have more sympathy for the lawyers, since their mission is to be an advocate.  Scholars should be seeking truth.

Investors can seek the truth or lose money — your choice.

In the investment world people regularly offer effusive praise for pundits whose opinions never changed over a multi-year period.  This is supposed to be good.  I am working on a series about the financial crisis.  Many of the leading participants changed positions with the evidence, as one would expect.  Others have been consistent for a decade, despite changing circumstances.

Current Question — Will it All Turn Out Badly?

I have often suggested that investment prospects all come down to earnings — both current and future.  From my perspective earnings prospects have improved.

As you read current investment commentary you might want to apply Dr. Browne's test.  Ask whether the pundit is starting with the conclusion or is a candidate for your Hall of Fame.

I really do not want to single out anyone while introducing this idea, but here is the general theme.

There is a doom and gloom camp that has a changing and incorrect story:

  • Earnings and the economy would collapse again in 2009.  That did not happening.
  • Earnings were based only on cost-cutting, not revenue.  Instead, revenue is improving.
  • Margins will decrease when workers revolt.  This is certainly not happening yet, and it is not very plausible.
  • Earnings come from the Fed, the Treasury, excessive debt, or something.  The worries get vaguer and go deeper into the future.  We shall see.

Meanwhile, no objective evidence seems to sway the doomsters.

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  • Mike C March 11, 2010  
  • nemo March 11, 2010  

    This may be true…but if the medium for exchange becomes worthless…

  • Jeff Miller March 11, 2010  

    Mike C — Thanks, and thanks for the link.

  • Roman March 11, 2010  

    What are you doing Jeff??
    Stop it. Stop with this “thinking” idea.
    We are all going to hell in a handbasket because of Obama and his death panel health care plan. And I will refuse to acknowledge anything else that doesn’t confirm this viewpoint.
    *******************SARCASM OFF************************
    Sadly, this is the viewpoint of at least 30% of the American public and in my opinion this political climate is the biggest financial risk in the medium and long term.
    In the short term (5-10 years), we are pretty safe in stocks. But in the medium term (10-25 yrs) and especially in the long term, we are screwed because there will not be any political will to do what is necessary to solve America’s problems.

  • tom brakke March 12, 2010  

    An orientation to the exploration of ideas and the willingness to change your mind are critical tools for investors, as you indicate.
    One complication is the notion of time horizon. Perma-bears and perma-bulls are equally worthless, but it’s important to be able to assess the situation in advance of the crowd and stand it against it for some period of time if need be. (Again, in either direction.)
    Right now, the perspective of time has shrunk so much that if you are “wrong” for a few days, you are “wrong” period. Figuring out how to arbitrage the immediacy of now versus the odds of the future may be the most needed skill of all in modern markets.

  • anonymous March 13, 2010  

    The technical term for what you’re talking about is Confirmation bias.
    The Accrued Interest blog (now discontinued) had a post in 2006 in a similar vein: Lawyers vs. Detectives.
    Count me firmly in the doom and gloom camp, by the way, but that’s a topic for another post. We shall see, indeed.

  • Jeff Miller March 17, 2010  

    Roman — How right you are! Thought, less thought…..
    That seems to be the mantra.
    Thanks for the chuckle.