"Uncertainty is the friend of long-term value buyers."

Author: Smart Investor

According to Xinhua News Agency, on July 21st local time, U.S. President Biden announced his withdrawal from the 2024 presidential election. After announcing his withdrawal, Biden stated that he would fully support Vice President Harris to obtain the Democratic Party's nomination.

Since the debate with the current President Biden, especially after the shooting incident at the rally, the calls for former President Trump to return to the White House have been increasing… Overseas investment institutions' forecasts have fluctuated significantly.

Some have mentioned that Trump will not forget the companies that restricted his social accounts when he was about to leave office, and some analysis believes that he will cut government projects, which is unfavorable to new energy. Some institutions have also proposed that the more differentiated the capital market performance, the better, and so on.

We all remember that when Trump was unexpectedly elected for the first time, the market thought it was doomsday, risk premiums soared, and the stock market collapsed for a while. 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 unexpectedness is greatly reduced, investors will find it hard to avoid an emotional roller coaster.

In the latest investment memo on July 17th, Howard Marks was inspired by an article about elections, focusing on why predictions in the political, economic, and capital market fields often fail.

The common point of these three fields is that they are influenced by psychological fluctuations, irrationality, and randomness, so there is fundamentally no certainty.

Howard also mentioned a point that he had never written about, that there is a seemingly paradoxical connection between money and wisdom.

"When people become wealthy, others will think that it means these people are very smart; when investors succeed, people often think that their intelligence and insight can also apply to other fields, and even successful investors themselves may have this feeling."

He believes that the success of investors 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 they may not be, but successful investors often do not know more about topics outside of investment than most people.

The period before the November election is destined to be a long process.

Perhaps we should learn from Dr. John Templeton, who intentionally read the Wall Street Journal a few days later, or perhaps while making adequate preparations and acting cautiously, we should also repeatedly recite a quote from Buffett, "Uncertainty is the friend of long-term value buyers."

The Stupidity of Certainty

By Howard Marks

The inspiration for my memos usually comes from various sources, and the inspiration for this memo comes from an article in The New York Times on Tuesday, July 9th.

What caught my attention at the time were a few words in the subtitle: "She has no doubt."

The speaker in the article was Ron Klain, former chief of staff to Biden, and the theme of the article was whether President Biden should continue to run for re-election. The "she" in the subtitle refers to Jen O'Malley Dillon, Biden's campaign team leader.

The theme of my memo is not to discuss whether Biden will continue to run or withdraw from the election, nor is it whether he will win if he continues to run, but that no one should be 100% certain about anything.

Considering that Biden's candidacy is still uncertain, this will be another of my "short" memos.

This topic reminded me of a time when I heard a very senior professional express absolute certainty.

A recognized expert in foreign affairs told us, "The possibility of Israel 'knocking out' Iran's nuclear capabilities by the end of the year is 100%." He looked like a real insider, and I had no reason to doubt his words.

I remember this happened in 2015 or 2016, if I were to defend him, he didn't specify which year.

As I pointed out in my memo "The Illusion of Knowledge" in September 2009, macro forecasters cannot accurately incorporate all the known variables that will affect the future, as well as the random influences that we know little or nothing about.

For this reason, as I have written in the past, investors and others affected by the unpredictable changes in the macro future should avoid using words like "will," "won't," "must," "can't," "always," and "never."

Political Field

Recalling the approach of the 2016 presidential election, almost everyone was certain about two things:

(a) Hillary Clinton would win; (b) If Donald Trump won by some twist of fate, the stock market would collapse.

Even the least certain scholars believed that there was an 80% chance of Hillary winning, and other predictions continued to rise on this basis.

However, Trump won, and the stock market rose by over 30% in the following 14 months.

The reaction of most forecasters was to adjust their models and promise to do better next time.

My conclusion is: if this is not enough to convince you that (a) we don't know what will happen; (b) we don't know how the market will react to what actually happens, then I don't know what will.

Returning to the present, even three weeks before the highly anticipated presidential debate, no one I knew expressed too much certainty about the upcoming election results.

The woman mentioned at the beginning of this article, Jen O'Malley Dillon, may now soften her stance on Biden's inevitable victory, explaining that the debate results surprised her.

But that's the problem! We don't know what will happen.

There is indeed randomness!

When things develop as expected, people will say they knew what would happen. And when things deviate from people's expectations, they will say that if there were no unexpected circumstances, the prediction would not have been a problem.

However, in either case, unexpected circumstances can occur, which means that predictions can be wrong.

Macroeconomic Field

In 2021, the Federal Reserve believed that the inflation that was occurring at the time would prove to be "transitory," defining it as temporary, non-fundamental, and possibly self-correcting inflation.

My view is that if you stretch the time long enough, the Federal Reserve may be proven right.

Inflation may recede within three to four years, provided that:

(a) The pandemic relief funds that have led to a surge in consumer spending are exhausted; (b) Global supply chains return to normal. (But there is also a logic here that if the pace of economic growth is not slowed down, it may trigger inflation expectations/psychology within these three to four years, requiring stronger action).

However, since the Federal Reserve's view was not confirmed in 2021, waiting any longer is untenable, so the Federal Reserve was forced to launch one of the fastest tightening cycles in history, which had far-reaching effects.

By mid-2022, the Federal Reserve's tightening measures almost certainly would have triggered an economic recession. A significant increase in interest rates would have an impact on the economy, which is also reasonable.

History clearly tells us that significant tightening by central banks often leads not to a "soft landing," but more often to economic contraction.

However, the fact is that the economy did not experience a recession.

On the contrary, by the end of 2022, the market consensus shifted to:

(a) Inflation is easing, giving the Federal Reserve room to start cutting rates; (b) Rate cuts will help the economy avoid a recession, or ensure that any contraction is mild and short-lived.

This optimism ignited a rally in the stock market at the end of 2022, which has continued to this day.

However, the rate cut expectations that supported the market rebound in 2023 did not materialize. In December 2023, the "dot plot" representing the views of Federal Reserve officials showed an expectation of three rate cuts in 2024, and the market optimists directly doubled that expectation to six rate cuts.

Halfway through 2024, inflation remains high, and there has not been a single rate cut. The market unanimously expects the first rate cut to come in September, and the stock market continues to reach new highs in this sentiment.

The current optimists may say, "We are right. Just look at the gains!" However, they are simply wrong about the rate cuts.

For me, this is just another reminder that we don't know what will happen, and we don't know how the market will react to what happens.

My favorite economist, Conrad DeQuadros of Brean Capital, provided an interesting tidbit on this topic for economists:

I will 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 surveyed predict a decline in real GDP in the next quarter, the recession has ended or is near its end.

In other words, the only thing that can be certain is that economists should not express any conclusions.

Capital Markets

Very few people were able to correctly predict in October 2022 that the Federal Reserve would not cut interest rates in the next 20 months. If this prediction had led them to exit the market, they would have missed out on a 50% increase in the S&P 500 index.

For the rate cut optimists, their judgment on interest rates was completely wrong, but they have likely made a lot of money now.

So, it's difficult to judge market behavior correctly. I don't intend to spend time listing the mistakes of so-called market experts here.

Instead, I want to focus on why so many market predictions have failed.

The trends of the economy and companies may tend to be predictable because their development trajectory… I should say… reflects the operation of mechanisms.

In these areas, people might say "if A leads to B, then it will happen with some certainty." Or in the absence of hindrance to trends and effective inferences, there is a probability of some correctness in these predictions.

But market fluctuations are much greater than those of the economy and companies. Why is that? Because the psychology or emotions of market participants play an important role, and there is unpredictability. To illustrate the degree of market volatility, let's continue to use data from economist Conrad:

40-year standard deviation of annual percentage change

Why do stock price fluctuations far exceed those of the underlying economy and companies? Why is market behavior so difficult to predict, and often unrelated to economic events and company fundamentals?

The "science" of finance—economics and finance—assumes that every market participant is rational: they make rational decisions to maximize their economic interests. However, the key role played by psychology and emotions often leads to the failure of this assumption.

Investor emotions fluctuate greatly, overwhelming the short-term impact of fundamentals.

As a result, there are relatively few market predictions that have been proven correct, and even fewer that are "correct for the right reasons."

Implications

Today, experts and scholars have made various predictions about the upcoming presidential election. Many of their conclusions seem logical and even convincing.

Some believe Biden should withdraw, while others believe he should not; some believe he will withdraw, while others believe he will not; some believe he will win if he continues to run, while others believe he will undoubtedly lose.

Clearly, having intelligence, education, data access, and analytical abilities is not enough to ensure making correct predictions. Because many of these commentators possess these qualities, and obviously, they can't all be right.

I often quote the famous economist John Kenneth Galbraith. He said, "There are two kinds of forecasters: those who don't know, and those who don't know they don't know." I really like this quote.

Another quote comes from his book "A Short History of Financial Euphoria." When discussing the reasons for "speculative frenzy and programmatic collapse," he discussed two factors, "which our time or past times have seldom noted, one of which is the extreme brevity of financial memory."

I have mentioned this in previous memos.

But I don't remember writing about the second factor he called the "seemingly paradoxical connection between money and wisdom."

"When people become wealthy, others will think that it means these people are very smart; when investors succeed, people often think that their intelligence and insight can also apply to other fields. In addition, successful investors often believe in their own wisdom and express opinions on topics unrelated to investment.

However, the success of investors 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 they may not be, but successful investors often do not know more about topics outside of investment than most people.

Despite this, many people are still not hesitant to express their opinions, and these opinions are often highly regarded by the public. This is the seemingly paradoxical part.

We find that some of them are now expressing their views on issues related to the election with great certainty.

We all know some people whom we describe as "often wrong, but never in doubt."

This reminds me of another favorite quote from Mark Twain (which may have some truth): "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

In mid-2020, when various phenomena of the pandemic seemed to be under control, I slowed down the pace of writing memos, no longer writing one every week as I did in March and April.

In May, I wrote two memos unrelated to the pandemic, titled "Uncertainty" and "Uncertainty II," in which I discussed the theme of cognitive humility at length.

These two memos are one of my favorite topics, but they didn't generate much response. I quote a passage from "Uncertainty" in the hope of giving everyone a reason to revisit them.

Here is an excerpt from the article that initially caught my attention on the theme of cognitive humility:

Li Ka-shing gave a talk at Shantou University in 2017, titled "The Power of Will." He said:

According to the author's definition, cognitive humility is the opposite of arrogance or conceit. In layman's terms, it is similar to open-mindedness. Intellectually humble people can have firm beliefs, but they are also willing to admit their mistakes and be proven wrong on various things (Alison Jones, Duke Today, March 17, 2017).

…In simple terms, humility means saying "I don't know, but…" or "I might be wrong, but…" I think this is an essential quality for investors; I am sure that I like to interact with people who possess this quality…

If you start your sentences with phrases like these, you won't get into big trouble, including "I don't know, but…" or "I might be wrong, but…"

If we acknowledge the existence of uncertainty, we will conduct due diligence before investing, repeatedly check our conclusions, and act cautiously. In times of prosperity, we will optimize, and it is unlikely to encounter "stalling" or collapse.

Conversely, those who are very certain may abandon the above behaviors, and once they make a mistake, as Mark Twain implied, the result could be catastrophic…

…As Voltaire summarized 250 years ago: doubt is not a pleasant condition, but certainty is absurd.

In conclusion, in fields influenced by psychological fluctuations, irrationality, and randomness, there is no certainty. Politics and economics are two such fields, and investing is also one. In these fields, no one can reliably predict the future, but many people overestimate their abilities and still try to do so.

Abandoning certainty can keep you out of trouble. I strongly recommend doing so.

Postscript

The Grand Slam tennis tournament last summer provided inspiration for my memo "Fewer Losers, or More Winners?" Similarly, the women's final of the Wimbledon tennis tournament last Saturday provided a footnote for this memo.

Barbora Krejcikova defeated Jasmine Paolini to win the women's tennis final.

Before the final, Krejcikova's odds were 125 to 1. In other words, bettors were certain she would not win. Perhaps their doubts about her potential were correct, but they seemed to be too certain about their predictions.

Speaking of the unpredictable, I cannot fail to mention the recent shooting incident at a Trump rally, which is likely to have more serious and far-reaching consequences.

Even though the incident is over now, and President Trump has narrowly escaped serious injury, no one can say for certain how this will affect the election (although it seems to have helped Trump's prospects at the moment) or the market.

Therefore, if there is any impact, it reinforces my bottom-line principle: prediction is largely a loser's game.

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