As of the start of 2019, it has been twenty years since I left NASA and started to work in finance. My first job in the private sector was in the emerging field of weather derivatives for a major energy trading firm. This was the era of energy trading that is most often associated with Enron. I worked in energy trading and risk management for about five years before gradually transitioning into quantitative analysis of mainstream asset classes (stocks, bonds, commodities). Looking back over these two decades, here are some of my ‘big picture’ observations.
During my years in finance, we have experienced two enormous crashes in financial markets, the dot-com bust of 1999-2000 and the crash of 2008. In between, there was another substantial decline in 2002. The markets recovered from each of these declines, and people who invested for the long-term have been well-rewarded. Over time frames of ten years or more, the stock market has been a good bet, even over a 20-year period with two huge crashes and one intermediate decline.
Prior to the crash of 2008, many market commentators asserted that we had somehow conquered the market cycle and that massive spikes in volatility were a thing of the past. People really thought this and discussed ‘the great moderation‘ in financial risk. It is very dangerous to think that we have conquered or sidestepped market cycles or that we truly understand all the sources of risk.
Another lesson that I have learned is that the markets often signal the potential for trouble quite clearly, even as people ignore the signs as a result of the enthusiasm that sets in after a long bull market. See this article that I wrote back in 2007, for example.
During bull markets, people become indiscriminate in what they are willing to pay for various goods. These periods don’t end well. During the dot-com bubble, people ignored standard measures of corporate finance and drove prices of tech firms to insane highs. In the real estate bubble of the mid-2000’s, house prices went to crazy highs relative to every rational measure of value–but many people set reason aside and believed that they were investing geniuses. The current bubble in which people seem to ignore costs is higher education. There is no good or service that is so valuable that price doesn’t matter, but that seems to be the current standard in college costs.
Another observation over the past twenty years is that we place too much faith in what we think of as ‘normal’ relationships between economic factors. We believe that there is some long-term equilibrium that markets and economies adhere to. Reality has the remarkable ability to ignore what we think of as the way that things are supposed to behave. Economic theory suggests, for example, that low unemployment should lead to higher wage growth, as companies compete for workers. In the current economic expansion, however, wage growth has been slow despite extremely low unemployment figures. Many economists are waiting for wage growth to return to ‘normal’ for a low-unemployment environment, even though it seems clear that advancing technology has disrupted the old unemployment-wage growth relationship. Technological improvements tend to slow wage growth by reducing the skill levels required for a range of jobs.
Over my time in finance, I have also witnessed a number of incredible financial frauds. The most notable were the rise and fall of Enron and the Madoff scandal, although Theranos definitely deserves a mention. In these cases, the fraudsters promised incredible potential and financial gains that defied logic–but many people (investors, financial journalists, analysts and even auditors) fell for the stories. The lesson is that many people will believe what they want to believe, even when common sense suggests caution.
Perhaps the most dramatic lesson in my time in finance is that, contrary to what classical economic theory suggests, people are not terribly rational. Behavioral finance has boomed in the last couple of decades, demonstrating that people are far too confident in their own acumen and often blindly follow the investing herd rather than thinking independently, as the aforementioned investing bubbles aptly demonstrate. Many people are also painfully short-sighted in terms of consumption decisions, discounting their future needs (e.g. retirement savings) in favor of what they want right now.