Author: Smart Investor
According to Xinhua News Agency, on July 21 local time, US President Biden announced his withdrawal from the 2024 presidential election. After announcing his withdrawal, Biden said he would fully support Vice President Harris for the Democratic nomination.
Since the debate with current President Biden, and especially after the shooting at his rally, calls for former President Trump to move back into the White House have been growing...Forecasts from overseas investment institutions have fluctuated dramatically.
Some people mentioned that Trump will not forget the company that restricted his social media accounts when he was about to leave office. Some analysts also believed that he will cut government projects, which will be detrimental to new energy. Some institutions also suggested that the more differentiated the capital market is, the better the performance will be.
We all remember that when Trump was unexpectedly elected for the first time, the market saw it as the end of the world, risk premiums soared, and the stock market collapsed. But within a few hours, the market changed its mind and started the Trump bull market.
Fast forward eight years. If Trump is elected this time, although the possibility of surprise is greatly reduced, it will be difficult for investors not to ride an emotional roller coaster.
In his latest investment memo on July 17, Howard Marks was also inspired by an article about the election and focused on why predictions in the three areas of politics, economics, and capital markets often fail.
What these three areas have in common is that they are subject to psychological fluctuations, irrationality and randomness, so there is no certainty at all.
Howard also mentioned a point he had never written about, that there is a specious connection between money and wisdom.
“When people become wealthy, others assume that means they are smart; when investors become successful, people tend to assume that their intelligence translates into other areas, even the successful investors themselves.”
He believes that "investors' success may be the result of a series of lucky events or favorable conditions rather than the result of any special talent. They may be smart or not, but successful investors often don't know more than most people about topics other than investing."
The process before the November election is destined to be a long one.
Perhaps we should learn from Dr. John Templeton and intentionally read the Wall Street Journal a few days later. Or perhaps, while we make adequate plans and act cautiously, we should also repeatedly repeat what Buffett said, "Uncertainty is the friend of long-term value buyers."
The Folly of Certainty
By Howard Marks
I usually get inspiration for my memos from a variety of sources, and this one was inspired by an article in The New York Times on Tuesday, July 9.
What caught my attention at the time were the words in the subheading: "She had no doubt."
The speaker in the article is Ron Klain, Biden's former chief of staff, and the theme of the article is whether President Biden should continue to run for re-election. The "she" in the subtitle refers to Jen O'Malley Dillon, Biden's campaign manager.
The article also quoted her as saying on June 27, a few days before Biden's debate with former President Trump: "Biden will win, there is nothing else to say."
The point of my memo is not to discuss whether Biden will continue to run or drop out of the race, or whether he will win if he continues to run, but that no one should be 100% sure of anything.
Given the uncertainty surrounding Biden's candidacy, this will serve as another "short" memo from me.
This topic reminds me of a time when I heard a very senior professional express absolute certainty.
A recognized foreign affairs expert told us that “there is a 100 percent chance that the Israelis will ‘take out’ Iran’s nuclear capability by the end of the year.” He seemed like a genuine insider, and I had no reason to doubt his words.
I remember it was in 2015 or 2016, if I were to defend him, he didn’t say which year it was.
As I pointed out in my September 2009 memo, “The Illusion of Knowledge,” it is impossible for macro forecasters to correctly account for the many variables that we know will affect the future, as well as the random influences about which we know little or nothing.
That’s why, as I’ve written in the past, investors and others subject to the vagaries of the macro future should avoid words like will, won’t, must, can’t, always and never.
politics
When the 2016 presidential election came around, almost everyone was certain of two things:
(a) Hillary Clinton will win;
(b) If Donald Trump wins by some quirk of fate, the stock market will crash.
Even the least confident scholars believe that Hillary has an 80% chance of winning, and other predictions continue to rise on this basis.
Yet Trump won, and the stock market rose more than 30% over the next 14 months.
Most forecasters respond by tweaking their models and promising to do better next time.
My conclusion is this: If this isn’t enough to convince you that (a) we don’t know what’s going to happen and (b) we don’t know how the market will react to what actually happens, then I don’t know what will.
Back in the present, even before the much-anticipated presidential debate three weeks ago, no one I knew expressed much certainty about the upcoming election results.
Ms. O'Malley Dillon, mentioned at the beginning of this article, may now soften her stance that Biden must win, explaining that the debate results surprised her.
But that's the problem! We don't know what's going to happen.
Randomness does exist!
When things develop as expected, they will say that they knew what would happen. When things develop differently from people's expectations, they will say that if there were no unexpected events, there would be no problem with the prediction.
However, in either case, there is a chance that something unexpected will happen, meaning that the forecast will be wrong.
The difference is that in the latter case, the accident happened; while in the former case, the accident did not happen, but this does not deny the possibility of an accident.
Macroeconomics
In 2021, the Fed believed that the inflation then occurring would prove to be "transitory," defining it as temporary, non-entrenched, and likely to be self-correcting.
My view is that if you stretch the timeline long enough, the Fed may be proven right.
Inflation could probably dissipate on its own within three or four years if:
(a) The exhaustion of pandemic relief funds, which led to a surge in consumer spending;
(b) The global supply chain returns to normal. (But there is another logic here. If economic growth is not slowed down, it is possible to trigger inflation expectations/psychology in the next three or four years, thus requiring stronger action).
However, since the Fed’s view was not borne out in 2021, waiting any longer was untenable, and the Fed was forced to initiate one of the fastest rate hikes in history, with far-reaching consequences.
The Fed’s rate hikes are all but certain to trigger a recession in mid-2022. It makes sense that a big increase in interest rates would hit the economy.
History clearly tells us that a drastic tightening by the central bank often does not lead to a "soft landing" but more to economic contraction.
Yet the fact is that there is no recession.
Instead, by the end of 2022, the market consensus shifted to:
(a) Inflation is easing, giving the Fed room to start cutting interest rates;
(b) A rate cut would enable the economy to avoid a recession or ensure that any contraction is mild and short-lived.
This optimism ignited a stock market rally in late 2022 and has continued to this day.
However, the expectations of a rate cut in 2023 that supported the market’s rebound did not materialize. In December 2023, when the “dot plot” representing the views of Fed officials showed that there would be three rate cuts expected in 2024, the market’s optimists doubled it and expected six rate cuts.
We are already halfway through 2024, inflation remains high, and there has not been a single rate cut. The market is unanimous that the first rate cut will come in September, and the stock market continues to hit new highs under such sentiment.
The current optimists might say, “We were right. If you don’t believe me, look at the increase!” But they are fundamentally wrong about the rate cuts.
To me, this is just another reminder that we don't know what's going to happen or how the market is going to react to what happens.
One of my favorite economists, Conrad DeQuadros of Brean Capital, offers a tidbit on the subject of economists:
I would use the Philadelphia Fed's Anxious Index (the probability of a decline in real GDP in the next quarter) as an indicator of the end of a recession.
When more than 50% of economists in a survey predict a decline in real GDP in the next quarter, a recession is over or nearly over.
In other words, the only thing that can be said with certainty is that economists should not express any conclusions.
capital market
Few people correctly predicted in October 2022 that the Fed would not cut interest rates for the next 20 months, and if that prediction kept them out of the market, they missed out on a 50% gain in the S&P 500.
As for the rate cut optimists, they were completely wrong about the interest rate, but they are likely to have made a lot of money now.
So, there you have it, market behavior is hard to judge correctly. I am not going to spend time here listing the mistakes of the so-called experts in the market.
Instead, I want to focus on why so many market predictions fail.
Economic and corporate trends may tend to be predictable because their trajectories… I should say… reflect the mechanisms at work.
In these areas, one can say with some certainty that "if you start at A, you will reach B," or that there is a certain probability that the prediction will be correct if the trend is not hindered and the inference is valid.
But the volatility of the market is greater than that of the economy and companies. Why is this? Because the psychology or emotions of market participants play an important role and are unpredictable. To illustrate the degree of market volatility, let us continue to quote economist Conrad's data:
40-year standard deviation of annual percentage change
Why do stock prices rise and fall so much more than the economies and companies behind them? Why is market behavior so unpredictable and often unrelated to economic events and company fundamentals?
The financial "science" - economics and finance - assumes that every market participant is an economic person: they make rational decisions to maximize their own economic interests. However, psychology and emotions play a key role that often leads to errors in this assumption.
Investor sentiment fluctuates widely, overwhelms the short-term impact of fundamentals.
Because of this, relatively few market forecasts are proven correct, and even fewer are “correct for the right reasons.”
Extension
Today, experts and scholars have made various predictions about the upcoming presidential election. Many of their conclusions seem reasonable and even convincing.
Some people think Biden should withdraw, while others think he should not; some people think he will withdraw, while others think he will not; some people think he will win if he continues to run, while others think he will definitely lose.
Obviously, intelligence, education, data access, and analytical skills are not enough to ensure correct predictions. Because many of these commentators possess these traits, and obviously, they will not all be correct.
I often quote the famous economist John Kenneth Galbraith. He said, "There are two kinds of forecasters: those who are ignorant and those who do not know they are ignorant." I love this quote.
Another quote comes from his book A Short History of Financial Euphoria. In describing the causes of “speculative manias and programmed collapses,” he discusses two factors “seldom noticed in our own time or in past times, one of which is the extreme transience of financial memory.”
I have mentioned this many times in past memos.
But I don’t recall ever writing about the second factor he mentioned, which Galbraith called “the paradoxical connection between money and wisdom.”
When people become wealthy, others assume that this means they are smart; when investors are successful, people tend to assume that their intelligence can lead to similar success in other areas. In addition, successful investors tend to believe in their own intelligence and to comment on areas unrelated to investing.
However, an investor's success may be the result of a series of lucky events or favorable conditions rather than the result of any special talent. They may or may not be smart, but successful investors often do not know more than most people about topics other than investing.
Despite this, many people are not shy about expressing their opinions, which are often highly valued by the public. This is the specious part.
We find that some of them are now expressing their views with conviction on issues related to the election.
We all know people whom we describe as “often wrong, but never in doubt.”
This reminds me of another one of my favorite Mark Twain quotes (and maybe there is some truth to it): "What you don't know can't trouble you, but what you do know for sure won't."
As early as mid-2020, when the various phenomena of the epidemic seemed to be under control, I slowed down the writing of memos and no longer wrote one per week as I had in March and April.
In May, I wrote two memos unrelated to the pandemic, titled “Uncertainty” and “Uncertainty II,” in which I devoted much of the space to the topic of cognitive humility.
These two memos are one of my favorite topics, but they have not received much attention. I quote a passage from Uncertainty to give you a reason to revisit them.
Here is a portion of the article that originally drew my attention to the topic of humility:
In 2017, Li Ka-shing gave a talk at Shantou University titled "Life of Willpower". He said:
According to the author's definition, epistemic humility is the opposite of arrogance or conceit. In layman's terms, it is similar to open-mindedness. Intellectually humble people can have strong convictions but are also willing to admit they are wrong and to be proven wrong about a variety of things (Alison Jones, Duke Today, March 17, 2017)
…Simply put, humility means saying “I’m not sure,” “The other person might be right,” or even “I might be wrong.” I think it’s a must-have trait in an investor; I know for sure that I like to associate with people who have it…
You won't get into big trouble if you start your sentences with statements like "I don't know, but..." or "I could be wrong, but..."
If we acknowledge that uncertainty exists, we will do due diligence before investing, cross-check our conclusions, and act with caution. We will suboptimize when times are good and be less likely to experience a “flash” or crash.
Conversely, someone who is overly confident may forgo such action, and if it goes wrong, as Mark Twain suggests, the results can be disastrous . . .
…As Voltaire concluded 250 years ago: Doubt is not a pleasant state, but certainty is absurd.
In short, there is no certainty in areas that are subject to psychological fluctuations, irrationality, and randomness. Politics and economics are two such areas, and investing is another one. In these areas, no one can reliably predict the future, but many people overestimate their abilities and try to do so anyway.
Giving up certainty can keep you out of trouble. I highly recommend you do this.
Notes
Just as last summer's Grand Slam tennis tournaments inspired my memo, "Fewer Losers, or More Winners?" last Saturday's women's Wimbledon final also provided a footnote to that memo.
Barbora Krejcikova won the women's tennis final by defeating Jasmine Paolini.
Before the championship, Krejcikova's odds were 125 to 1. In other words, bettors were sure she wouldn't win. They might be right to doubt her potential, but they shouldn't have been so sure of their predictions.
Speaking of unpredictable things, I cannot fail to mention the recent shooting at the Trump rally, which is likely to have more serious and far-reaching consequences.
Even though the incident is now over and President Trump has escaped serious injury, no one can say for sure what impact it will have on the election (although it appears to have helped Trump's prospects so far) or the markets.
So if anything, it reinforces my bottom line principle: forecasting is largely a loser’s game.
