Intellectual humility is often regarded as one of the most important traits to succeed in investing. So, when Howard Marks writes a memo on it, we have to feature it for he has been quite vocal on the subject of the inherent uncertainty in investing, markets and the economy. Yet, many of us mistake a lucky streak for skill and fall into the certainty trap.
He gives examples from politics, economy and markets where even if we could get what was a fairly uncertain event right, it was hard to predict the consequence of that event making forecasting in these fields with randomness inherently futile. One such example from politics he cites:
“When the 2016 presidential election rolled around, there were two things about which almost everyone was certain: (a) Hillary Clinton would win but (b) if by some quirk of fate Donald Trump were to win, the stock market would collapse. The least certain pundits said Clinton was 80% likely to win, and the estimates of her probability of victory ranged upward from there.
And yet, Trump won, and the stock market rose more than 30% over the next 14 months. The response of most forecasters was to tweak their models and promise to do better next time. Mine was to say, “if that’s not enough to convince you that (a) we don’t know what’s going to happen and (b) we don’t know how the markets will react to what actually does happen, I don’t know what is.”
…Sometimes things go as people expected, and they conclude that they knew what was going to happen. And sometimes events diverge from people’s expectations, and they say they would have been right if only some unexpected event hadn’t transpired. But, in either case, the chance for the unexpected – and thus for forecasting error – was present. In the latter instance, the unexpected materialized, and in the former, it didn’t. But that doesn’t say anything about the likelihood of the unexpected taking place.”
It is not just inherent randomness in the world. Market uncertainty is furthered by the fact that markets are driven by its participants’ emotions and not rational thinking as presumed generally. He shows the 40yr standard deviation (volatility) for the economy (GDP), corporate profits and the market (S&P 500) as 1.8%, 9.4% and 13.1%.
“…markets swing more than economies and companies. Why? Because of the importance and unpredictability of market participants’ psyches or emotions
Why is it that stock prices rise and fall so much more than the economies and companies that underlie them? And why is it that market behavior is so hard to predict and often seems unconnected to economic events and company fundamentals? The financial “sciences” – economics and finance – assume that each market participant is a homo economicus: someone who makes rational decisions designed to maximize their financial self-interest. But the crucial role played by psychology and emotion often causes this assumption to be mistaken. Investor sentiment swings a great deal, swamping the short-run influence of fundamentals. It’s for this reason that relatively few market forecasts prove correct, and fewer still are “right for the right reason.”
…Obviously, intelligence, education, access to data, and powers of analysis can’t be sufficient to produce correct forecasts. Many of these commentators possess these attributes, but clearly, they won’t all be right.”
The memo has some quotable quotes:
“…the only thing worthy of certainty is the conclusion that economists shouldn’t be expressing any of it” – Howard Marks himself
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” – John Kenneth Galbraith
“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.” – Mark Twain
“Doubt is not a pleasant condition, but certainty is absurd” – Voltaire
And what’s even more absurd is this:
“When people get rich, others take that to mean they’re smart. And when investors succeed, it’s often assumed their intelligence can lead to similarly good results in other fields. Further, successful investors often come to believe in the strength of their own intellect and opine about fields with no connection to investing.
But investors’ success can be the result of a string of lucky breaks or a propitious environment, rather than any special talents. They may or may not be intelligent, but often they don’t know any more than most others about subjects outside of investing. Nevertheless, many are unsparing with their opinions, and those opinions often are highly valued by the general populace.”
This is where intellectual humility stands out.
“…intellectual humility means saying “I’m not sure,” “The other person could be right,” or even “I might be wrong.” I think it’s an essential trait for investors; I know it is in the people I like to associate with. .
…There simply is no place for certainty in fields that are influenced by psychological fluctuations, irrationality, and randomness. Politics and economics are two such fields, and investing is another. No one can predict reliably what the future holds in these fields, but many people overrate their ability and attempt to do so nevertheless. Eschewing certainty can keep you out of trouble. I strongly recommend doing so.”
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