Poker, Probabilities and Brinksmanship
Some of us will remember the date: October 14, 1962. It’s been 57 years since the start of the Cuban Missile Crisis, an event which put the world on the brink of nuclear war. It happened in the middle of the Cold War, when school children were routinely taught to hide under their desks in the event of an attack. At that time, the U.S. discovered that the Soviet Union was deploying medium range ballistic missiles on Cuban soil. This would become the biggest test of John F. Kennedy’s presidency. Seeing this as an obvious threat to national security, Kennedy’s advisors prepared several options to consider, including an invasion of Cuba. The President, however, feared that too aggressive a military response could trigger a military escalation from the Soviets, possibly starting a nuclear war. Kennedy put the U.S. military on “maximum alert” and weighed all of his options, knowing that delaying his decision meant that more Cuban missiles would become operational.
He eventually decided not to attack Cuba directly, but, instead, implemented a naval blockade of Cuba to prevent Soviet ships from delivering more missiles. This decision gave the Soviets time to reconsider their Cuban strategy, and, after several days, the Soviet ships turned around. On October 29, the Soviet Premier Khrushchev backed down, and agreed to remove all Soviet missiles from Cuba. The whole world could breathe again. Kennedy’s decision had brought the world back from the brink.
Even though Kennedy was said not to be a poker player, historian Paul Johnson wrote that Kennedy had “called Khrushchev’s bluff.” Annie Duke, a former professional poker player, has written a good book on how to improve our decision making: Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts. It’s a well-written and very practical book, full of pertinent stories to illustrate important points, including, for all you Chicago Cubs fans, the unfortunate circumstances surrounding the Cubs World Series playoffs in 2003. She carefully explains many behavioral biases we all struggle with when we have to make decisions. It is not, however, a book on how to play better poker.
Duke makes an important point early in her book: if life is like a game, it is more like poker than it is like chess. Chess is a game where everyone can see all the game pieces at all times. There’s nothing hidden and no room for luck. She writes “If you lose at a game of chess, it must be because there were better moves that you didn’t make or didn’t see. Poker, in contrast, is a game of incomplete information. It is a game of decision-making under conditions of uncertainty over time.” If you lose at poker, it is possible that the outcome was due to pure chance and not the quality of your playing decisions.
We certainly do live in an uncertain and unpredictable world. Duke says that good poker players and good decision makers are both comfortable knowing that the world is this way. She warns us, however, to beware of all-or-nothing thinking or an inability to say “I don’t know.” She says all decisions are bets on the future and, as such, involve an element of risk or uncertainty that our decisions may not end as well as we might have hoped.
Some of us are not used to thinking this way, that future outcomes of our decisions can be thought of as statistical probabilities. We usually make decisions in the hope that everything will turn out as we originally hoped, and there’s nothing wrong with this for many of our routine day-to-day decisions. But Duke points out that not being aware of probabilities can be problematic because we tend to think in terms of right or wrong. She writes that the 2016 Presidential Election is a good case in point. A well-known prediction website had placed the probability of Donald Trump winning the election at between 30% and 40%. When the election results were announced, many were upset that the forecast “got it wrong,” but, writes Duke, “An event predicted to happen 30% to 40% of the time will happen a lot.”
As investors, thinking this way can be a big help to us in how we emotionally react to the daily gyrations in the stock market, but we have to be intentional about it. We have to be able to move seamlessly between our intellectual knowledge and our visceral reactions. Suppose, for example, that you believe there is a 50% chance that the U.S. stock market will fall by over 25% sometime within the next three years (this is hypothetical). Let’s assume that it actually happens two years from now. How will you feel then? Will you let your “rational” self (who made the prediction) inform your “emotional” self (who is now reacting emotionally to the actual event)?
Don’t get me wrong. I’m no emotionless robot. Market downturns are never easy to experience, no matter how “rational” we may claim to be. Research suggests that a given percentage loss (even a “paper loss”) is experienced with twice the emotional impact as the same percentage gain. But we need to keep a long-term orientation to these events when they happen (and I put a high probability that market downturns will keep happening).
Maybe looking at a real-life example will help keep things in perspective. Hard to believe, but during the actual Cuban Missile Crisis, U.S. stocks only fell 7%. However, from December of 1961 to June of 1962, stocks had already experienced a steep sell-off, having fallen over 25%. But from the day Khrushchev “blinked,” the market proceeded to rise over 62% until February of 1966 (excluding dividends).
Allow me to end this with one of my favorite Warren Buffet quotes: “America has faced the unknown since 1776…American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor.”
John serves as Chief Investment Officer for Coyle Financial Counsel and is responsible for overseeing the investment process. John’s prior experience includes managing institutional fixed-income portfolios for corporations, pension funds, non-profit organizations and foundations at several large, global asset managers. With more than 20 years of institutional investment experience, he is energized by helping individuals understand the role investing plays in meeting their long-term financial goals.
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 Paul Johnson, Modern Times Revised Edition: The World from the Twenties to the Nineties (Harper Perennial Classics) Revised Edition (2001)
 Annie Duke, Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts (Penguin, 2018)
 Finance.yahoo.com S&P 500 Index (accessed 10/10/19)