A year ago, I reviewed what financial markets and other prediction markets were anticipating for 2013: these markets provide us with the world’s most boring almanac, but also perhaps the most informative—aggregating as it does all of the views of everyone who is willing to back their opinion with money.
Looking back at that review, the most striking event of 2013 for investors was the strong equity market performance: the total return on the Russell 3000® Index for the year was 33.6% and on the Russell Global Index, 24.4%. That’s not quite off the charts (the price of options a year ago implied perhaps a 5% chance of a U.S. market return of 33% or higher). But it’s a remarkably good outcome nonetheless.
The point of that article, of course, was not to make specific predictions for 2013, but rather to make the point that sometimes it’s more important to think in terms of probabilities. And, in similar vein, my big prediction for 2014 is simply that it’s going to be a year of surprises. If equity markets don’t surprise in 2014, then it’s likely that either bond markets will, or real estate markets, or political events, or economic growth in one or more regions, or options, or commodities, or… well, you get the picture. Indeed, it would be quite a surprise if nothing surprising happens.
The need to think in terms of probabilities hardly qualifies as breaking news, of course, but it’s good to be reminded of it sometimes. Indeed, there’s a behavioral bias that makes us all tend to underestimate the effect of uncertainty. This bias comes from the human propensity to rationalize the past. It is pretty well-documented that human beings tend to regard past events as pretty obvious after they have happened – so much so that we feel like we saw them coming better than we actually did. It’s the same selective memory that makes gamblers remember their wins more clearly than their losses.
And because the past does not feel as surprising as it should, the future does not seem as uncertain either. Turning the past into a more predictable, better-behaved world than it really was can make us picture the future as the same. But the truth is that every day something happens that has never happened before.
Another striking event of 2013 for those of us who like to track prediction markets is that one of the three sources of information I used a year ago (intrade) closed down following pressure from the CFTC. That’s a shame for academics, economists and other commentators who like to have quick and easy access to market-based probabilities of future events ranging from political elections to weather events. There’s nothing quite like a market for accurately aggregating the views of the masses.