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The problem with making predictions in an uncertain world

The problem with making predictions in an uncertain world
The past year, while tumultuous, has seen astounding innovation, not to mention Covid-19 vaccines being developed at warp speed. This should buoy the the pace of global GDP growth in 2021. (Image: Adobe Stock)

If anything, 2020 should have made us wary of predictions. As author and wealth manager Barry Ritholtz said recently, 2020 will be remembered for how wrong so many were about so much.

First published in Daily Maverick 168

In the late 1990s, a team of young tech journalists believed that the internet was going to change the world in unimaginable ways. We told this to anyone who would listen – particularly our peers in mining, which we saw as a sunset industry. In terms of the trend, we were broadly right. But as far as profitable investments went, I, for one, couldn’t have been more wrong. The tech collapse is a memory I won’t forget in a hurry, while investments in platinum and the like kept my mining colleagues smiling for years.

Which goes to show that identifying trends or “big economic ideas” is one thing, but making profitable predictions from them is another thing entirely.

If anything, 2020 should have made us wary of predictions. As author and wealth manager Barry Ritholtz said recently, the year 2020 will be remembered for how wrong so many were about so much. From the pandemic to the election, and from the economy to financial markets, prognosticators did a horrible job. Yet, as 2020 draws to a close, those same prognosticators can’t help making predictions about the next 12 months – and we can’t help but read them.

As far back as 1933, US economist Alfred Cowles concluded that even the most successful market forecasters did “little, if any, better than what might be expected to result from pure chance”. People know this by now, but more than anything else people dislike not knowing and are comforted by baseline expectations. “A world in which nobody really knows can be frightening,” Cowles recognised. “They want to believe that somebody really knows.”

This is fine and perfectly understandable. The biggest problem with predictions is not predictions themselves, but that we human beings consistently disregard the possibility that unexpected and random events will inevitably occur. In other words, they tend to cling to the “big idea” that I mentioned above.

For instance, few coming out of the gloom of the 2008/09 financial crisis would have believed that the stock market was about to enter its longest bull market in history and stock investors would gain 300% over the next 12 years.

This year is, of course, filled with similar examples. One that struck me came from one of the world’s leading venture capital firms, Sequoia Capital, which is known for getting its bets right. Sequoia is currently eating humble pie after it advised its portfolio companies in a widely circulated “Black Swan” newsletter in March to rein in spending, cut jobs and adapt to a new economic reality.

What the very recent past tells us, they say, is that above all else, the level of uncertainty around the future has increased. Financially, this level of uncertainty is reflected in the volatility of asset prices. Add to this elevated valuations of most international asset classes and they arrive at the conclusion that prudence dictates one should err on the side of caution.

It is a humble pie of the more delicious variety, as investors in at least two Sequoia funds will see elevenfold returns on paper this year, after fees, and a third fund will see eightfold returns, according to Bloomberg.

What the Sequoia managers recognised, correctly, was that containing the virus could take several quarters and that it could take even longer for the global economy to recover its footing. What they and others did not factor in while the virus was storming across the globe, infecting millions, leaving countless jobless and decimating small businesses, was that this is not 2008, and some sectors would benefit greatly from the pandemic.

Unlike in 2008, the financial system is not on the brink of collapse, central banks around the world moved swiftly to implement strong countermeasures and governments injected as much stimulus into their economies as they could afford.

So, while the decline in GDP was worse than many predicted, the market decided to put the whole pandemic in its rear-view mirror and party like it was 2021.

The truth is that they were not alone in getting it wrong, and the investors who made the most money this year were those who reacted the fastest to the changing circumstances and not those who stuck to grandiose predictions.

Embracing the idea that you can’t predict the future, but you can be prepared for it is extremely powerful. Success in the market is mostly a function of effective reaction, a clear trading strategy and recognition that we don’t know what the future may hold.

The team at Gryphon Asset Management, whose analysis is fundamental and methodical, argue that predicting the future requires careful analysis of the past rather than the extrapolation of current circumstances and conditions into the future.

What the very recent past tells us, they say, is that above all else, the level of uncertainty around the future has increased. Financially, this level of uncertainty is reflected in the volatility of asset prices. Add to this elevated valuations of most international asset classes and they arrive at the conclusion that prudence dictates one should err on the side of caution.

Is this a prediction? No. But it certainly is a baseline position from which further research and analysis can be done.

This also does not mean that they are, or any of us should be, negative about the future. The past year has been tumultuous, but it has seen astounding technological and entrepreneurial innovation, not to mention pharmaceutical companies delivering a Covid-19 vaccine at warp speed.

One can certainly expect that this innovation will continue into the future. And we can expect that buoyed by Covid-19 vaccines, the pace of global GDP growth will pick up in 2021. For many, it won’t feel like a boom, as the global recovery is likely to be lumpy, with different sectors and countries recovering at different speeds, depending on access to vaccines and economic circumstances.

However, when it comes to asset prices and financial markets, one doesn’t need Wall Street prognosticators to tell us that at current levels markets are high – and from there, anything could happen. DM/BM

This is an opinion piece by Sasha Planting, associate business editor of Maverick Business.

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Comments - Please in order to comment.

  • Nos Feratu says:

    Indeed, anything can happen. Especially the unexpected. For what it’s worth, I predict that Covid will be with us until at least 2025 and that it will take 1.5 to 2 billion lives before the end of its cycle.

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