Dangers of psychological groupthink
THERE is something strange about human psychology – or at least, a major flaw in the way we extrapolate trends based on a very limited amount of recent historical data. This is of major importance to the way we make predictions about the economy and the performance of individual companies.
Whenever something goes badly wrong for a long time, the assumption almost invariably becomes that this is the new normal; most forecasters then become too pessimistic. Booms produce the opposite result: forecasters become far too optimistic, especially during the tail end of the good days. Those who remain calm throughout the cycle make the best forecasters; but groupthink and panic mean that they are often shunned, mocked and even hounded out of their jobs. Take the media industry. At the height of the bubble, analysts used to think that the total amount of advertising in the world economy would keep on growing at an extremely fast rate; eventually, there would be so much of it that hundreds of new firms – such as Facebook – would easily make a killing relying on it. Then came the recession – and after a few disastrous quarters of falling GDP and an even worse slump in ad dollars, the mood and fashion changed. Suddenly, everybody started to argue that it was all over, that the total volume of advertising would be permanently much reduced and would never bounce back and that all advertising-based business models were defunct.
As you might imagine, both extreme viewpoints were faulty. Advertising expenditure has started to recover, though of course the market remains tough. ITV, a firm that was written off just a few months age, will see its 2010 advertising growth hit 10.9 per cent, and earnings rise by 10 per cent, according to bank of America Merrill Lynch (which remains overall bearish on the firm). US magazines – which were widely believed to be in terminal decline as a result of the web and the downturn – enjoyed a 5.7 per cent growth in advertising revenues in the second quarter. For the first time in nine quarters, both total magazine pages and rate-card-reported revenue posted gains, according to Publishers Information Bureau. It is also now clear that the free daily newspaper model can work wonders when executed properly.
Another example of excessive bullishness, followed by excessive bearishness is, of course, commentators’ perception of the health of the overall economy. I remember when Shriti Vadera talked of green shoots in early 2009; she was spot on – the money markets had just started functioning again – yet she was ridiculed. For months after that, newspapers were forecasting a 1930s-style depression and a total collapse, long after it was clear that the worst of the financial crisis was over and that it was merely a matter of time before things stabilised. Now many commentators have convinced themselves that we are facing another, double-dip recession and that unemployment will remain elevated for ever. Of course, they may end up being right (though I very much doubt it) but the point is that these sorts of forecasts are all too predictable. They always follow recessions. Forecasts tend to undershoot in the early stages of a recovery and to overshoot at the peak of the boom. The best analysts and investors are those who understand this – and hold their nerve when everybody around them falls prey to groupthink.
allister.heath@cityam.com