The New Year head fake and the danger of recency bias

Every couple of weeks I send an email out to Materials Risk subscribers linking to some of the best research I’ve found freely available on the Internet – much of it published by investment banks and other institutions. While I endeavor to only send out the most interesting and thought provoking pieces I have stumbled across it’s important to state that some of it should come with a wealth warning, especially this time of the year.

You see, the start of the year often marks the point that investors, full of hope – or dread – for the year ahead feel compelled to make wholesale changes to their portfolio. Selling the dross that under-performed last year, and piling into the shiny new thing. This note of caution was prompted by a tweet from Real Vision founder Raoul Paul in which he outlines how asset managers approach the start of the year.

As Raoul cautions, the narrative around the reflation trade is one such consensus call that he fears could get unwound early in 2021. That of course would be negative for commodities. As I outline in me earlier piece, commodities are one of the trades of the next 10+ years and so and any investor should have a long-term perspective, being in a position to add on weakness, and not going all in too soon.

That brings me to my second point. Be aware of how recency bias may influence your decisions. As the table below shows (click here for an interactive version) past performance is no guarantee of future performance. Poor returns for one commodity during a calendar year does not mean that its fortunes will be reversed over the following 12 months. A prolonged period of being in the black (witness palladium’s run of 5 consecutive years of double digit returns) does not mean that black will definitely come up again this year

Remember, the calendar year is an arbitrary period of time. There is no rhyme or reason why you should feel compelled to make too many changes just because everyone is saying you should. There is no reason why performance observed in one year will correlate with the following year. Instead, better to be aware of the motivations of others and be ready to adjust accordingly when other investors (high on hope or fear) react in disappointment.

As billionaire hedge fund manager Seth Klarman said “The single greatest edge an investor can have is long-term orientation. In a world where performance comparisons are made not only annually and quarterly but even monthly and daily, it is more crucial than ever to take the long view.”

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