The Past Speaks

I’ve long suspected that investors draw on their stock of  historical information to try understand the present, especially during crises, when the risk and uncertainty are at elevated levels. During crises, many investors seem to conclude that the standard ways of valuing assets and making decisions don’t seem to be working that well. All it takes for the financial newspapers to be filled with historical contents about Tulipmania, 1929, Smoot-Hawley, deglobalization, and the origins of the First World War is some sort of “black-swan” event that upsets normal business conditions. Back during the Global Financial Crisis, my fellow business historians were excited when people in finance started paying more attention to business history in the search for guidance in uncertain times. Bloomberg established its short-lived Echoes column during that crisis to supply finance people with historical insight.

By Mikael Häggström, M.D.- Author info- Reusing images – Own work, CC0, https://commons.wikimedia.org/w/index.php?curid=87223640

In the last decade, I’ve developed my understanding of the literature in psychology and economics that helps us to understand when investors are most likely to have recourse to historical knowledge. A great starting point for thinking about this issue is Barry Eichengreen (2016)’s book-length study of how historical knowledge was used by central bankers during the Global Financial Crisis. Eichengreen grounds his study by the dual-process model of cognition that practitioners are most likely to associate with Danny Kahneman’s  scholarly papers and his best-selling departure lounge business book Thinking Fast and Slow. Kahneman’s research strongly suggests to me  that historical thinking is especially influential during crises rather than in normal conditions, when individuals make greater use of “System 2” thinking. Research by other psychologists future supports the idea that individuals would greater recourse to the cognitive tool of “historical analogy” during periods of uncertainty (see Chan and Paletz, 2019).

Right now, markets are in chaos as investors who have no specialized training in epidemiology are struggling to figure out how they should respond to coronavirus (see here, here, and here). Some observers have debated whether the SARS epidemic of early 2000s is a reliable guide for thinking about the likely impact of coronavirus on firms and markets. As Covid-19 began to disrupt global supply chains, many investors drew on an analogy with SARS to make sense of what was going to happen next. For examples of people using a historical analogy with SARS to try to think about the likely impact of coronavirus, see here, here, and here. Bank of America economist Ethan Harris has recently said that “unfortunately, the analogy doesn’t work.” Nicholas Colas of DataTrek Research opposed the use of the historical analogy, saying that it is “useless to compare how US/global equities fared under SARS in 2003 to the coronavirus today.” See here. One can totally understand why these observers are wary of using this historical analogy. Global supply chains have changed a lot since 2002, especially since China is a much more important economy today than it was at the time of SARS.

By russellstreet – 1918 Influenza Epidemic Site, CC BY-SA 2.0, https://commons.wikimedia.org/w/index.php?curid=36234676

For a while, I’ve been following the excellent blog of Jamie Catherwood, a young finance practitioner who shares my conviction that historical knowledge, particularly the knowledge of the history of financial markets is potentially quite useful to investors.

Image from Jamie Catherwood’s Twitter Account https://twitter.com/jfc_3_/status/1095868909142593536?s=20

Catherwood’s day job is as as a  Client Portfolio Associate at O’Shaughnessy Asset Management, a long-equity investment firm in Connecticut. Catherwood’s blog, Investor Amnesia, appears to have something of a cult following in financial circles, as it is has inspired reader meet-ups in different North American cities (see list here). Anyway, in a blog post yesterday (1 March), Jamie wrote:

I can honestly say that since I started doing my financial history shtick online in June 2018,  I have never received so many questions and requests for historical context than I did with the coronavirus this week. It was this week that many Americans witnessed a previously distant and global problem become a serious concern at home as more cases of coronavirus in the United States were reported. In response, stocks tanked as investors panicked over how the global pandemic would impact markets and supply chains.

The blog post has lots of interesting information about historical pandemics, but to me the most interesting passage in it is the sentence that I have quoted above. Jamie’s observation is another data point that supports my theory that investors are more likely to reach for history when there is a war on.