Going For It On 4th Down - Connecting Quarterly: 4th Quarter 2017

Dear Friends,

This Sunday, over 110 million people will sit down to an annual American tradition:  The Super Bowl. Amongst them will be the coaching staffs of the 30 NFL teams not fortunate enough to play in this year’s “Big Game.” Those coaches, the vast majority of whom have never coached in a Super Bowl, will undoubtedly be thinking the same thing: “What can I do to get my team there next year”? They will probably consider traditional ways to try to improve their teams:  Convince the owner to spend more money to bring in a new quarterback; devote more time to college scouting in an attempt to find the next great superstar; prepare better by learning their opponent’s tendencies. Many of the approaches they might consider have been tried in one form or another by coaches for decades, yet most of those coaches continue to fall short of their goals.

Fifteen years ago, a high school football coach in Arkansas decided to take a different approach. Kevin Kelley, the coach at Pulaski Academy in Little Rock, doesn’t have a typical football coach’s resume. He didn’t play football in college. He majored in Accounting for his first two years and his favorite book is one of the “Freakonomics” series. Early in his coaching career at Pulaski, Kelley came across a business paper written by a University of California, Berkeley professor entitled “Do Firms Maximize?  Evidence from Professional Football.” The paper took a mathematical look at the decision football coaches face when they have the ball on fourth down:  Punt the ball 30-40 yards back to the other team, or attempt to make a first down and risk giving the ball to the other team at its current place on the field? Traditional thinking is that attempting to go for it on fourth down is dangerously risky, and something that should generally be avoided. However, when the author crunched the numbers he concluded that the data clearly showed that “going for it” every time on fourth down, no matter the circumstances, was the optimal strategy.    

Kelley decided to boldly follow the data, rather than the traditional thinking. Many football “experts” ridiculed his approach as being too risky, not because they had alternative data, but because Kelley’s strategy didn’t appeal to their traditional football beliefs. But Kelley kept the faith that the odds were in his favor. He even did his own research on some other common coaching decisions that led him to adopt more “evidence-based,” but unusual approaches, such as always doing an onside kickoff and always attempting a two-point conversion, rather than the easier one-point version. To hear Kelley describe his philosophies in more detail, see this video.

The results over Kelley’s 15-year career have been astounding:  His teams have won 179 games, and lost/tied only 26. He has led Pulaski to four consecutive state championships, and has seven state championship victories in eight tries.1  So why hasn’t Kelley’s math-based approach been more widely adopted by other high school, college or professional coaches? It seems the coaching community has a greater desire to follow the herd and its traditional thinking than to embrace new approaches, even when those novel approaches are supported by strong statistical evidence of producing better outcomes.

Like the traditionalist football coaches described above, following “conventional”, but false, wisdom can hurt investors. 2017 was an amazing year in the U.S. stock market. The S&P 500 index was up over 20% for the year and for the first time in the index’s 92-year history, it rose in every single month of the year.2 The biggest market decline during 2017 was a paltry 3%, the smallest in a generation.3 Many financial forecasters and investors believe that an historic year like 2017 changes the odds, favorably or unfavorably, that the market will produce gains in 2018. Unfortunately for those speculators, the evidence tells us otherwise:

The chart above tells us that since 1896, the Dow Jones index has gone up in about 65% of past calendar years. It also tells that whether the market rose or fell last year, the odds of gains in the following year are no different: About 65%. Even a market gain of 20% or more in the previous year does not change the likelihood of a gain or loss in the following year. In short, there is no historical evidence to support changing your allocation to stocks based on last year’s returns.

Kevin Kelley goes for it on fourth down every time. It doesn’t matter if his quarterback is playing well or poorly in the game, or whether his team is ahead or behind. He ignores the “armchair quarterbacks” and trusts that he’ll come out ahead more often than not. We think investors would be well served to follow a similar evidence-based approach to asset allocation. While there is always a chance of a loss, history tells us the odds of stock market gains are better than 50/50 no matter what happened last year. Staying invested in the stock market won’t make a “first down” every time, but in the long run maintaining a disciplined, consistent allocation to stocks that reflects your specific goals is the most prudent approach.

As always, we welcome your questions and comments.

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Chuck Carroll, CFA, CAI
Chief Investment Office
TFO Phoenix, Inc

1  “ALL-USA Football Coach of the Year: Kevin Kelley, Pulaski Academy (Ark.)” USA Today, December 20, 2016, updated with 2017 record from MaxPreps.com.

2 Data Source:  Dimensional Returns 3.0

3 Data Source:  JPMorgan