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Even Stranger than Strange

Yogi Berra’s quip that it is difficult to make predictions, especially about the future, is highlighted by rogue traders, such as Nick Leeson at Barings Bank, Jérôme Kerviel at Société Générale, Yasuo Hamanaka at Sumitomo, and Toshihide Iguchi at Daiwa Bank, who each lost at least a billion dollars for their respective employers betting on stock market index futures, commodities, or bonds.6 We might discount these cases as exceptions to a normally functioning system. But consider LTCM, led by John Meriwether, the former head of bond trading at Salomon Brothers, advised by Nobel Prize winners Myron Scholes and Robert Merton, and employing a stable of quantitative analysts building sophisticated financial and risk models. LTCM lost nearly $5 billion in a few months and then permanently closed its doors.

It’s not just LTCM. Over a 15-year period, virtually all mutual fund and bond fund managers underperformed the broader market.7 Nobel economics Laureate Daniel Kahneman conducted a simple analysis of finance professionals in a leading firm: The interyear correlation of results was essentially zero.8 Such data can be interpreted as suggesting that winning a lottery is not proof of skill in winning lotteries.

California Institute of Technology (Caltech) professor Leonard Mlodinow has similar data showing a regression to the mean for money managers, underscoring that past performance is no guarantee of future results.9 One problem with forecasting financials, ...