Our Limitations... Our Habits...

Not too long ago, The Economist wrote an article about an academic paper that I’ve since learned is called “Evidence for a conserved quantity in human mobility” by Laura Alessandretti and Andrea Baronchelli, both in the Mathematics Department at City University of London, and Sune Lehmann at the DTU Technical University of Denmark.  If you can’t quite get the gist of the paper’s subject from that title, let me tell you what it’s about because it’s pretty fascinating.

It turns out that regardless of where we live – town or country or thriving metropolis -- we generally visit the same places regularly over months and years.  Moreover, not only do we tend to visit the same places, but there also is a limit to the number of places we can handle frequenting.  On average, the number of places we go to in any given period is limited to 25.  Of course, we do discover new places.  But if we start going to a new place, an old one drops out.  In other words, 25 places is our upper limit – and according to the authors, there’s reasonable evidence that this is not due to lack of time. 

So what is it?  While the authors don’t yet understand it fully, they are thinking that it is something about us that cognitively limits our geographical behavior.  We are not relentless explorers.  As The Economist says, we are not the “footloose and fancy-free” creatures we might imagine ourselves to be. 

The authors started out by tracking 1000 university students, which showed that students returned to a limited number of places even though the places changed over time.  What surprised the authors was that when they expanded the study to tracking 40,000 smartphone users around the world, the general population was similarly geographically limited.

Many questions come to mind here.  My first thought was, “Really?  Seriously?”  My second was, “Do I even make it to 25 places regularly?”  My third was, “Only 25?” And my fourth, of course, was “Why?”

There are two things you might think of immediately.  One is that we really are creatures of habit.  You know it, we all know it.  I park in the same parking spot every time I turn up at the pool for my morning swim.  I almost always start off in the same direction when I walk my dogs – I don’t even think about it.  Habits make it easier to get through the day.  They are comfortable.  They reduce the cognitive load on us. 

But variety also is the spice of life.  So we do like finding new places.  As Dr. Baronchelli says, “People are constantly balancing their curiosity and laziness.  We want to explore new places but also want to exploit old ones that we like.”  Yet in any case it’s clear that when new places come in, old places go out.

That brings up the other consideration: that our brains just have limits.  The authors of the study suggest that their findings may be very much akin to Robin Dunbar’s work on how many social relationships we can maintain.  Dunbar, an anthropologist and psychologist, was the one who found connections between animal brain size and the complexity of their social networks.  His conclusion was that the number of people individuals can keep in their social circle maxes out at around 150.  That  is called the Dunbar number.  Actually, there are a series of Dunbar numbers: We are capable of having 150 casual friends, 50 people we’d call close friends (good enough for a dinner party), 15 intimates, and 5 in the closest inner circle.  The point is that going over those numbers is too complicated for us to process optimally.

The question all this raises is, given our limits, isn’t it a good thing to force ourselves to jettison the familiar more often than we’d like?  Is it possible we could become more creative and more flexible?  I read not too long ago in the FT that one man forced himself to order something new off the menu every time he went to same restaurant because he thought it helped him stay flexible in this tech-driven age. 

In any case, sticking with the familiar sometimes surely isn’t optimal.  Just think of the home-country bias many investors have – that is the preference for Americans to invest in U.S. stocks because it’s familiar and comfortable even when U.S. GDP is only a quarter of world GDP.  This is one case where it may well be worth ordering something different off the menu.

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When Will The Party End?…

By almost any measure, the U.S. economy is in great shape.  At 3.9%, the U.S. unemployment rate is at historic lows. Inflation remains at reasonably low levels and economic growth, as measured by GDP, just hit its highest quarterly rate since 2014. But economies have a nasty tendency to go through boom and bust cycles and the current expansion is definitely long in the tooth. At 110 months, it is the second longest boom on record and almost 3 times longer than the 39 month average expansion.

Understandably, most investors are wondering when the party will end. Many of the traditional statistics that economists track suggest that we have no reason to worry but a few other indicators with strong predictive track records bear watching.

The Treasury Yield Curve: Mention the yield curve and most people’s eyes start to glaze over. The data contained in the graph below, however, has an impressive record of accurately predicting economic downturns. Historically, investors have demanded more compensation for holding longer dated bonds. The yield curve measures this “liquidity premium,” or the spread between the yield offered on 10-year Treasuries compared to 2-year Treasuries. In the past, this spread has narrowed as the Federal Reserve, in an effort to cool off an overheating economy, raised rates. But monetary policy is a blunt tool at best and often overly aggressive Fed action has pushed the economy into recession. History shows that once the spread goes negative (i.e., 2-year Treasuries yield more than 10-year Treasuries), recessions soon follow. The yield curve has not gone negative yet but today stands at a decade low 0.15%.

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Housing Starts: Residential housing contributes only about 3%-5% of U.S. GDP. However, factor in related spending on things like remodeling and utilities - - and housing as a whole contributes as much as 16%. Housing starts are a particularly good leading indicator of overall economic confidence; builders are reluctant to embark on new construction projects and consumers are reluctant to make such a large purchase if they are uncertain about the future.

Unfortunately, after several years of recovery (see chart above) housing starts have flat-lined around the 1.2 million mark.  So far, strong job and wage growth appears to be offsetting the negative impact of higher interest rates and housing costs, but this metric bears watching.

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The Unemployment Rate: Historically, the U.S. unemployment rate has troughed just before a recession. This outcome most likely reflects the fact that rising demand for labor during periods of strong economic growth tends to ignite wage inflation which in turns spurs aggressive Fed tightening. Where are we today? The unemployment rate has recently been oscillating between 3.8% and 4.0%. It is hard to imagine the rate going too much lower from here although, encouragingly, wage gains have remained relatively subdued.

Interestingly, while the three metrics discussed here have a pretty good track record of predicting recessions, the economists who track them do not. According to Ned Davis research, “economists, as a consensus, called exactly none of the seven recessions since 1970.”

If economists can’t predict the next recession, what is the average investor supposed to do? Remember that even if you can’t predict the business cycle, you can control your own behavior. Be sure your investment strategy accurately reflects your own risk tolerance and return objectives. An ample supply of cash too will help you ride out the economic storm when it comes and prevent you from having to liquidate holdings in a down market.