FOMC Recap: What lessons can the Fed learn from March Madness?

 

Let's be realistic, in 24 hours no one is going to be talking about this FOMC meeting, after all tip-off to the round of 64 of the NCAA Men's Basketball Tournament, "March Madness", is less than 24 hours away.  What lessons can the Fed learn from March Madness?

There's just something about March.  Dating back to 44 BC and the assassination of Julius Caesar, March has been associated with turmoil and uncertainty.  Shakespeare's famous line "Beware the Ides of March" certainly continues to portend bad omens in today's popular culture.  Away from ancient Rome, March has indeed had it's share of ominous moments in financial market history, just to name a few: March 2023 saw the failure of Silicon Valley bank, March 2020 saw some of the largest single day moves in rates and stock prices during Covid, March 2011 was the Japanese earthquake and Fukushima disaster, March 2010 was the height of the Greek debt crisis, March 2008 was the collapse of Bearn Stearns...you get the point.  Nevertheless, it's easy to forget the specific dates or even that the aforementioned financial market events all happened in March.

"March Madness", the basketball version, has better marketing and is less forgettable than financial market history. Like the fortuitous events that have occurred in the month of March over history, the NCAA version of March Madness is often filled with unexpected events, upsets and Cinderella stories.  We can remember 16 seeds (UMBC and FDU) upsetting 1 seeds, we can remember Christian Laettner's "The Shot", we can remember the Cinderella runs of N.C. State, Villanova and others, as well as the many future stars who became household names as a result of their play on the biggest stage in college basketball. 

The Fed can learn many lessons from March Madness, including:

• It is impossible to be perfect:  The odds of completing a perfect bracket are a number that is incomprehensible.  The odds that the Fed can steer the economy to perfection by moving an interest rate both gives the Fed too much credit and creates an illusion that something as complex as the economy is that controllable.
• Plans are worthless, but planning is everything (Dwight D. Eisenhower): In Eisenhower's words, "There is a very great distinction because when you are planning for an emergency you must start with this one thing: the very definition of "emergency" is that it is unexpected, therefore it is not going to happen the way you are planning. So, the first thing you do is to take all the plans off the top shelf and throw them out the window and start once more. But if you haven't been planning you can't start to work, intelligently at least.  That is the reason it is so important to plan, to keep yourselves steeped in the character of the problem that you may one day be called upon to solve--or to help to solve."
  Every college coach knows that you have to take in the data, do your homework and come up with a plan to attack your opponent.  In the same vein, every coach knows that their team has to survive the proverbial punch to the face.  The biggest stumbles in March Madness occur when some top seeded team, faces a team that comes out with a different style than expected.  When that higher seed fails to make any adjustments, upsets often follow.  The Fed can learn that sometimes things don't go according to plan, it doesn't mean you shouldn't have watched the film, taken in the data, etc. it means that as you watch the film and take in the data you need to make your plan robust and be willing to revisit and adjust. Just as good coaches call time out and get to make adjustments at halftime, the Fed needs to remember that sometimes what they thought was going to work, doesn't work as planned.   Maybe the Fed should consider this as the take in current inflation data.  Sometimes you have to change your defense to stop the streaky shooter.  Maybe inflation is today's streaker shooter and the Fed needs to step up it's defense. To the Fed's credit they are often very good at making adjustments when it matters most.  

While there are many more lessons the Fed and financial market participants can learn from the NCAA tournament, the primary lesson is one of learning that the future is uncertain, expect the unexpected and that anything can happen.

I'll end there, but if you want a little more on uncertainty, risk management and the parallels to the NCAA tourney, read on...

As for uncertainty on the whole and risk management, the wise words of the late Peter L. Bernstein are always worth revisiting.  

Q: How can investors avoid being shocked, or at least reduce the risk of overreacting to a surprise?

A: Understanding that we do not know the future is such a simple statement, but it's so important. Investors do better where risk management is a conscious part of the process. Maximizing return is a strategy that makes sense only in very specific circumstances. In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.

The riskiest moment is when you're right. That's when you're in the most trouble, because you tend to overstay the good decisions. So, in many ways, it's better not to be so right. That's what diversification is for. It's an explicit recognition of ignorance. And I view diversification not only as a survival strategy but as an aggressive strategy, because the next windfall might come from a surprising place. I want to make sure I'm exposed to it. Somebody once said that if you're comfortable with everything you own, you're not diversified. I think you should have a small allocation to gold, to foreign currency, to TIPS [Treasury Inflation-Protected Securities].

Can you manage yourself in a bubble, and can you manage yourself on the other side? It's very easy to say yes when you haven't been there. But it's very hot in that oven. And can you save your ego, as well as your wealth? I think I might have just said something important. Your wealth is like your children -- the primary link between your present and the future. You should try to think about it in the same way. You want your children to have freedom but you also want them to be good people who can take care of themselves. You don't want to blow it, because you don't get a second chance. When you invest, it's not your wealth today, but it's your future that you're really managing.

The above is an excerpt from an interview he did with the great journalist, Jason Zweig, back on October 15, 2004, as published in MONEY Magazine. 

Think about the parallels in Bernstein's answer to what you experience during March Madness. The impossibility of completing the perfect bracket is a reminder that we do not know the future. We also know that picking all upsets is rarely a winning strategy, as is picking all of the top seeds, a reminder to diversify.  For the teams playing in the tournament, they know they have to survive to advance, they have to be able to take the punch from the scrappy underdog team, they have to be able to survive a rough shooting night or the game their best player gets into foul trouble. In Warren Buffet's words, "In order to succeed, you must first survive." We also see examples of the teams that come into the tournament overconfident, maybe they're like investors in a stock market bubble. Their regular season record leads them to believe they can over look their first round matchup, perhaps they feel like they don't need to adjust their style of play and they learn that they over-stayed their good decisions. And lastly, sometimes the star player needs to let their ego go and not force up shots. Is that star player the Fed?  Time will tell.