By Robert Seawright, Proprietor, Above the Market
A shifting baseline is a change with respect to how a system is measured or evaluated, usually against previous reference points (baselines), which themselves may represent significant changes from even earlier states. For example, the price of coffee has seen a very significant baseline shift. A cup of coffee may have only cost a nickel in the 1950s, but with the advent of “premium coffee, the baseline is much higher today — $1.38 for brewed coffee and $2.45 for an espresso-based drink. Few of us look at current coffee prices based on the 1950s model. For most of us, our standard point of reference has moved and moved a lot.
This idea initially arose within the context of fishing management. Daniel Pauly developed the concept after he recognized that fisheries scientists often failed to identify the correct “baseline” population size (i.e., how abundant a fish species population was before human exploitation) and thus work with a shifted baseline. Interestingly, Pauly discovered that scientists tended to use as their baseline the state of the fishery at the start of their careers, rather than any earlier state. Accordingly, large declines in ecosystems or species over long periods of time can easily be hidden and each generation of experts tends to have a different perception of what is the appropriate starting baseline.
Pauly called this troubling ecological obliviousness shifting baseline syndrome. He described it thus: “Each generation of fisheries scientist accepts as baseline the stock situation that occurred at the beginning of their careers, and uses this to evaluate changes. When the next generation starts its career, the stocks have further declined, but it is the stocks at that time that serve as a new baseline. The result obviously is a gradual shift of the baseline, a gradual accommodation of the creeping disappearance of resource species.”. The lack of a long data timeline and significant changes to the data sets over time are seen as being particularly significant to this problem.
Subsequent research has verified the generational amnesia Pauly postulated, whereby knowledge extinction occurs because younger generations are not aware of past biological conditions and almost nobody goes back far enough – “normal” is determined by when they began their careers. But research also uncovered a personal amnesia, whereby knowledge extinction occurs as individuals (not scientists) ignore or forget their own experience. In this instance, the current situation is deemed normative and consistent with the past, even when it manifestly is not. Observers generally do not notice gradual changes in visual scenes in laboratory studies (“change blindness”), thus providing a conceptual framework for how this personal amnesia of environmental conditions could occur.
While research with respect to markets needs to be done for verification purposes, it isn’t hard to see the application of shifting baseline syndrome to investing. Markets provide even shorter timelines of data than the ecological sciences. Since we investment professionals don’t have enough data to determine what normal is, it shouldn’t surprise anyone that we tend to begin with the idea that “normal” is that which existed when we got started in the business. It’s more than a little like my thinking popular music peaked with the Beatles because they were a very big deal and I was a big fan when I was a kid.
Barry Ritholtz recently examined how our various frames of reference impact what we see and expect in the markets. More specifically, Barry was critical of our tendency (and desire) to categorize the current market environment as being like some earlier market environment. Without identifying it as such, Josh Brown interpreted Barry as pointing out shifting baseline syndrome by reminding us to ‘[s]top looking at the market through the lens of whatever your first year investing was.”
While it can be dangerous to extrapolate ideas across areas of inquiry, it appears from the research literature that shifting baselines syndrome tends to be suffered by professionals while personal amnesia is suffered by the “laity.” Thus we who are supposed to be the experts see the present through the lens of our earliest professional experience while investors see the present as the historical norm (recency bias). Accordingly, it should not be surprising that many investors are still paralyzed by the financial crisis, especially once our inherent risk aversion is factored in. While his confidence is probably misplaced (given how besetting and “sticky” our cognitive and behavioral biases are), as stated by one of the preeminent researchers in this field, “If the issue is with personal amnesia, just talking to people and triggering their memories about how things were…will help them to ensure that their perceptions of change are accurate.”
Professionals, on the other hand, determine “normal” based upon their formative years in the business. For some, that may be the high inflation days for the 1970s. For others, it may be the 1987 crash. For still others, it may be the go-go 1990s. Whatever your baseline, recognize your personal tendencies and try to add more data to the overall “equation.” Otherwise, neither the “new normal” nor the “old normal” will have much of a chance to be consistent with what actually is normal. Indeed, due to the relative paucity of available data — “modern” financial markets are barely 100 years old, if that – ”normal” isn’t even necessarily a relevant concept.