Probable Impossibilities

By Ray Ryan, CFA


Ray Ryan is the President of Patten and Patten, an investment management firm, and a Registered Investment Adviser in Chattanooga. Ray is a CFA Charter Holder, a member of the Advisory Board for UTC’s College of Business, and an Adjunct Professor of Finance at UTC. He is a graduate of Princeton University, where he had the privilege of taking a course taught by former Fed Chairman Ben Bernanke. 

An important component of the investment process is the identification of risks. However, one cannot reliably predict when and how risks might surface. Forecasting “unknown unknowns” is generally a fruitless endeavor. Nevertheless, the investment process should include a probabilistic assessment of risk as well as reward.


There is an old Wall Street adage that markets climb a “Wall of Worry.” Since the stock market began its recovery in 2009, many “experts” have argued that the market has risen because of “artificial” factors and monetary policy manipulation. Further, there seems to be profound worry that another calamity is “just around the corner.” A certain level of skepticism is reasonable and healthy, and some of the lack of trust in the stock market is justified. Since 2008, policy experts have failed to convincingly explain why the financial system collapsed. For this principal reason, investors worry that the safeguards established to “prevent another 2008” will prove inadequate. In addition, markets are confronted with new, unforeseen risks each year. In 2014, for example, there was heightened concern over Ebola. Despite assurances from medical experts, especially those that specialize in infectious diseases, widespread panic over a possible Ebola contagion contributed to market volatility. The science is rather clear that the probability of somebody contracting and perishing from Ebola is significantly less than that of the seasonal flu strain. Yet, such “evidence” failed to assuage the general public.

The reaction to Ebola was not surprising. A growing field of study known as behav- ioral finance would argue that the public’s reaction to Ebola in 2014 was representative of the “availability bias.” Availability bias is the human tendency to assign greater im- portance to events that attract heavy media coverage. In effect, media coverage fostered a perception that the probability of an Ebola pandemic was higher than was the case.

In general, the media tend to devote too much coverage to improbable possibilities such as Ebola. By doing so, they help foster a perception that those probabilities are higher than they really are. Perhaps the best known example of an improbable possibility is the lottery. Arguably, coverage by the media encourages more people to purchase lottery tickets than would otherwise be the case. Tickets are purchased despite miniscule probabilities for winning.

The financial media, particularly the broad- cast variety, have transformed reporting on the markets into a form of entertainment similar to what ESPN did to sports broad- casting. These networks regularly trumpet market milestones, and with a penchant for hyperbole, they have a large influence over sentiment as they swing the pendulum quickly from fear to euphoria. The media’s continued focus on improbable possibilities could be discouraging long-term investment in a zero interest rate environment.

While the financial media devote too much coverage to improbable possibilities, they dedicate little coverage to probable im- possibilities.

Since 1960, the stock market has suf- fered a correction of at least 10% every nine months, on average. Thus, there is a reasonable probability for a stock market correction each year. Yet a repeat of the financial crisis of 2008 is a low probability event, despite the efforts of media types that foster a perception that “another 2008” market scenario is imminent.

While the financial media devote too much coverage to improbable possibilities, they dedicate little coverage to probable impossibilities. Investors, therefore, should generally discount the media. Instead, investors would be wise to heed the words of an early philosopher, Aristotle, who argued that one should prefer “probable impossibilities to improbable possibilities.”

There was a perception pre-2008 that certain financial institutions were “too big to fail.” Consensus held that entities such as Fannie Mae and Freddie Mac would be rescued by the government at any cost. Their collapse, in other words, was considered “impossible.” Given the rescue of Bear Stearns, a bankruptcy by Lehman Brothers was considered “impossible” until nearly the exact moment the company filed.

The collapses of Lehman, Fannie, and Freddie were three of the principal catalysts for the market chaos and economic calamity during late 2008. Each of these perceived impossibilities became realities with devas- tating consequences because investors were unprepared. A handful of shrewd investors as- sumed that some of these impossibilities were indeed probable and bet against consensus.

Today, consensus believes that the Federal Reserve’s balance sheet is too large. There is a view that our country will never again balance its budget or pay off its debt. More immediate, there is widespread concern that the domestic economy cannot grow without extraordinary monetary policy support. In other words, con- sensus would consider balancing the budget, paying off the national debt, and growing with- out support from the Fed as “impossibilities.”

Such a perception ignores history. To suggest to somebody in the 1970s that the US would eventually pay off its debt would have invited ridicule. A national debt clock was erected at that time in New York City – a mechanism with which to remind people how miserable they should be. Yet in the mid-1990s, our policy makers entertained this prospect. After eliminating our annual budget deficit, policy makers such as Alan Greenspan actu- ally fretted over potential market disruptions created by elimination of the national debt. A mere two decades after erecting a clock to capture in real time the rapid accruals of our government’s borrowings, there was a debate as to whether eliminating our debt was, indeed, a good thing. An impossibility in the 1970s became probable only a few decades later.

In 2010, the US budget deficit exceeded $1.5 trillion. At the time, balancing the budget was pure fantasy. Yet, only five years later, the bud- get deficit is 67% smaller. Emergency measures enacted under the leadership of Dr. Bernanke while Chairman of the Federal Reserve were designed to prevent our economic system from collapsing and to establish a foundation from which to recover. Those policies were always designed to be temporary, expiration of which was contingent upon the ability of the economy to grow on a self-sustaining basis. The prospect of the Federal Reserve shifting monetary policy later this year confirms that the U.S. economy has begun to grow without the need for extraordinary support. Another perceived impossibility is about to become a reality, affirming Aristotle’s wisdom.

It is surprising that many people are concerned that the stock market recently set new record closing highs. That was clearly not the case in the late 1990s. There was a certain level of dissatisfaction at that time that the market was not climbing higher at a faster pace. Dur- ing the dot-com bubble years, consensus held that a stock market correction was impossible because of “New Economy” dynamics. In that regard, it is advisable to be more concerned when investors become complacent about risk; when there is excessive optimism in the market; and when valuations get stretched beyond fundamentals. Those conditions are not present today.