2nd Quarter 2013

Posted on July 25, 2013 · Posted in Newsletters

All this has been my fault. – Robert E. Lee, July 3, 1863 after Pickett’s Charge on the third day of the Battle of Gettysburg

It is hard to imagine the scene 150 years ago when, in the sweltering heat of July, the 72,000 soldiers comprising the Army of Northern Virginia under Robert E. Lee met the Union’s Army of the Potomac with forces of 94,000 under the command of George G. Meade.  After the initial skirmishes of the first day of battle, Lee met with Longstreet to discuss a course of action.  In his controversial accounts written after the war, James Longstreet recalled the following:

When I overtook General Lee at 5 o’clock that afternoon, he said, to my surprise, that he thought of attacking General Meade upon the heights the next day. I suggested that this course seemed to be at variance with the plan of the campaign that had been agreed upon before leaving Fredericksburg. He said: “If the enemy is there tomorrow, we must attack him.” I replied: “If he is there, it will be because he is anxious that we should attack him — a good reason in my judgment for not doing so.” I urged that we should move around by our right to the left of Meade and put our army between him and Washington, threatening his left and rear, and thus force him to attack us in such position as we might select.  -James Longstreet, General James Longstreet’s Account of the Campaign and Battle

Whether or not Longstreet’s accounts were embellished with time, there has been much speculation concerning Lee and the Battle of Gettysburg.  Lee was a deliberate general, a brilliant tactician and a collected battlefield commander.  At Gettysburg, the location was not chosen by Lee but determined by a chance encounter of advanced detachments of both armies.  By the second day, the Union occupied much the advantaged ground and a decisive victory would require heavy casualties against a numerically superior Union army occupying the better position.  Lastly, Lee was without his “eyes and ears,” Jeb Stuart and his cavalry, leaving Lee to issue commands to his generals without strategic intelligence.

One explanation is hubris compounded by recency and sample size biases.  After a series of victories, Lee began to believe in the invincibility of his army and the ineptitude of northern generals.  As a result, he modified the plan of the campaign and engaged in a battle with a lower probability of victory based on over confidence, brought on by a small sample of successful outcomes in the current campaign, rather than the deliberate and calculating approach he had executed so successfully during the entirety of the war.

Poor decision making is not the exclusive domain of generals.  Even outside of the military and examples like General Lee at Gettysburg we have seen substantial miscalculation due to over confidence.  In business, there was Ford’s launch of the Edsel brand in the late 1950s and Coca-Cola’s reformulation of Coke in 1985.  In politics, there was Dewey’s underestimation of Truman’s tenacity in 1948 and Nixon’s miscalculation of television’s effect on voter perceptions in 1960. In investing and in financial planning, we face the same emotional responses to outcomes as generals do in wars, business leaders do in product management and politicians do in election campaigns.

We have written several times about behavioral economics and investor psychology, highlighting the problems that investors and human beings face in battling our basic instincts.  With the stock market hovering near all-time highs, we have to be careful of recency bias and extrapolating these returns into the future without incorporating the probabilities of pockets of volatility that are unpredictable but quite real.  Like General Lee, in good times we tend to attribute a higher percentage of our positive results to skill rather than luck and overstate our forecasting abilities concerning future events.  As a result, we are willing to take on more risk when markets are calm but the probability of success is lower and less risk during turbulence when our odds improve.  As the amount of time increases from an adverse event, we begin to skew our perspective towards the more recent positive events thereby distorting our perception of risk.  Therefore, it is important to establish long term goals matched with a durable strategy so that we can endure these periods and move forward.