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Complicated
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” —John Kenneth Galbraith
After three straight losing weeks, the stock market rebounded last week, with the S&P 500 rising 3.65%. When things are going down, more so-called “experts” seem to forecast things to keep going down. When things are going up, we seem to notice more people showing up predicting things will keep going up.
Forecasts often reflect little more than the recency bias of the person or economist (to separate two very different creatures) making the forecast. They look at what’s going on in the world. They put some numbers in a spreadsheet. And then when asked to make a prediction, they rarely utter the words “I don’t know.”
Are forecasts about the macro future worth paying attention to? Or is the economy too complicated and intertwined to pass judgment on its future? In his latest memo, “The Illusion of Knowledge,” Howard Marks makes the case for the latter:
Forecasters have no choice but to base their judgments on models, be they complex or informal, mathematical or intuitive. Models, by definition, consist of assumptions: “If A happens, then B will happen.” In other words, relationships and responses. But for us to willingly employ a model’s output, we have to believe the model is reliable. When I think about modeling an economy, my first reaction is to think about how incredibly complicated it is.
…Unlike in the physical sciences, in markets and economies there’s very little that absolutely has to happen or definitely can’t happen. Thus, in my book Mastering the Market Cycle, I listed seven terms that investors should purge from their vocabularies: “never,” “always,” “forever,” “can’t,” “won’t,” “will,” and “has to.” But if it’s true that those words have to be discarded, then so too must the idea that one can build a model that can dependably predict the macro future. In other words, very little is immutable in our world.
… What’s to be assumed regarding the general macro environment under which economic participants will operate? Doesn’t this question indicate an insoluble feedback loop: To predict the overall performance of the economy, we need to make assumptions about, for example, consumer behavior. But to predict consumer behavior, don’t we need to make assumptions regarding the overall economic environment?
The macro economy is important when it comes to business and investment performance. Macro factors such as inflation and interest rates have a major impact on returns. But these are factors that have proven nearly impossible to predict with any kind of accuracy.
So how is an investor expected to handle such important but unforecastable macro factors? As we wrote last year in The Important and The Knowable, “The answer lies in observing the present, thinking about probable outcomes, and only acting when the odds are clearly in one’s favor.”
To some extent, any time we invest we are making a prediction about the future. Even when we observe the present and observe the current earnings and competitive advantages of a business—and base our expected returns based on those things—we are making the prediction that the current state will continue into the future.
And this is where price comes in. Warren Buffett once said that price is his due diligence. That’s only partly true, because both he and you and we still need to analyze the numbers and the people running a given business. But when you’ve done that work, based your thesis on a proven business model, and you wait for a price that gives you margin for error in that analysis, then you can ignore the unpredictable nature of the macro economy and focus on finding the next idea.
“The only function of economic forecasting is to make astrology look respectable.” —John Kenneth Galbraith
Windy City RoundUp Conference in Chicago
Over two days in October, investors can harness top stocks for their portfolios. They’ll meet with executive management teams from approximately 50-plus microcap companies across a wide variety of industries and gain an understanding into the key value drivers and potential trends for 2023.
Tweets of the Week
In Case You Missed It…
The Illusion of Knowledge - by Howard Marks
Good Enough - by Morgan Housel
Build a Better Small Biz Budget for 2023
Investing by the Books Podcast: #30 William Thorndike: The Outsiders
Planet MicroCap Podcast: Ep. 241 - The 5 Keys to Value Investing with J. Dennis Jean-Jacques
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