As humans, we love to make predictions. Doing so gives us a feeling that we have some control over what is happening around us, a feeling that is especially valuable in uncertain times such as these. But can we actually do this successfully? Howard Marks (Trades, Portfolio) recently explained why the answer to this question is no.
Who needs forecasts?
Marks strongly believes no one can predict the direction the coronavirus outbreak will take, and anyone that says that they can is just kidding themselves:
“There’s just no justification for having a confident view at the present time. Wall Street takes it as its job to fill the void with forecasts and information. I was talking to one of the major investment houses last week, and at that time they had cut their earnings estimate for the S&P 500 for the year from 173 to 158, which was a decline of about 15%. And when I next caught up with them, their estimate was 115! So the question in my mind is: do these estimates do any good? On the one hand, people like to have information, but what good is it to have information if its probability of being correct is low?”
I think Marks hits on a very important aspect of human psychology here. As humans, we are genetically driven to find reasons for things. “Why did the market go down? Because X caused Y, which caused Z.” We are great after-the-fact rationalizers. This is one reason why monumental events seem inevitable in retrospect. The problem is that no one sees these events coming. If you read the journal entries of soldiers and politicians from World War II, one thing that jumps out is how seemingly unaware they were of the importance of what was happening.
What does this mean for investors? It means that we are bad forecasters. It means that there is a lot of informational noise out there that does nothing but distract us from the fact that we really don’t know much. We create maps that more than often not match the terrain that we find ourselves in. And sometimes, having a bad map is worse than not having a map at all because it can lead you to some pretty dangerous places with a false confidence.
So what should investors do? Marks believes the most prudent thing to do is to manage your risk in an intelligent way. For him, the smart thing to do is hedge your bets, either with actual hedges or by holding extra cash in case the market continues to move lower. You might miss out on some gains, but that seems like a small price to pay for the comfort of knowing that you have some extra dry powder to deploy if the selling continues.
Read more here:
- Why Peter Lynch Loves Volatility
- What Activist Investors Do, According to Bill Ackman
- David Tepper Is Tentatively Buying
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