In his latest memo, 'The Folly of Certainty', renowned investor Howard Marks has addressed the challenges and pitfalls of market forecasting. Drawing inspiration from an article in The New York Times dated July 9, the memo by Oaktree Capital top boss Howard Marks talks about the problem of forecasting market outcomes with total certainty.
Marks highlights that when things don't go as predicted, market forecasters usually attribute their error to unforeseen events, even when the potential for the unexpected - hence the possibility of error - was always present. "When the unexpected occurs, it disrupts predictions, but when it doesn't, it still doesn't eliminate the inherent uncertainty," the Oaktree top boss wrote in his memo dated July 17.
Using this argument, Marks stated that while economic and corporate performance might be somewhat predictable, market behaviour is significantly harder to gauge due to investor's psychology and emotions. This, according to him, is one of the key reasons why market forecasts fail.
Market Behaviour vs Economic Predictability
Marks notes that fluctuations in the stock market - which are typically more than their underlying economies and companies - make market forecasting even more erroneous. To understand this, he discusses the limitations of traditional financial 'sciences'. He believes the performance of economies and companies might tend toward predictability, given that the forces governing them are somewhat mechanical.
Therefore, in these areas, forecasters might be able to predict with some degree of confidence, Marks wrote. However, these assumptions don't necessarily sit well with stock market as it assumes rational decision-making by all market participants.
"The financial “sciences” – economics and finance – assume that each market participant is a homo economicus: someone who makes rational decisions designed to maximise their financial self-interest. But the crucial role played by psychology and emotion often causes this assumption to be mistaken," Marks wrote. According to him, investors' sentiment is often guided by their psyche and emotions that leads to unpredictable market swings, thus making forecasts go wrong.
The Shadows of Overconfidence
Marks draws on the wisdom of John Kenneth Galbraith, who famously said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” He emphasises the misleading assumption that because an investor has succeeded in the stock market, their intelligence can lead to similarly good results in other fields too.
Rather, Howard Marks believes that success in investing can often be attributed to luck, rather than special talent. Despite this, successful investors frequently opine on unrelated fields, with their opinions being highly valued by the general populace.
Read Previous Howard Marks Memos Here.
The Importance of Intellectual Humility
Building on his previous idea that success in stock markets doesn't translate to intelligent ideas across other fields, Marks advocates for intellectual humility, suggesting that admitting uncertainty and recognising one's fallibility can lead to more cautious and ultimately more successful investment decisions.
He quotes Alison Jones from Duke Today, describing intellectually humble people as those who, despite having strong beliefs, are willing to be proven wrong and recognise their fallibility.
The Unpredictability of Markets
Marks' note underscores the unpredictability of markets and the dangers of overconfidence. He references the recent surprise win at Wimbledon and the unpredictable impact of political events, like the attempt on Donald Trump’s life as examples of the inherent uncertainty in predicting outcomes. Marks asserts that avoiding certainty and embracing intellectual humility can keep investors out of trouble, reinforcing the idea that making predictions is largely a loser's game.
In summary, Howard Marks' memo serves as a reminder of the complexities and uncertainties inherent in market forecasting, vouching for a cautious and humble approach to investing.
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