Future Financial Uncertainty

We quite rightly deride fortune tellers as charlatans and yet dress a man in an expensive suit and get them to forecast the future using elegant mathematics, and for some reason we wish to label them an expert/guru, or use such forecasts as the basis of our decision making.

Despite being smart enough to know that the future is unpredictable, we spend an huge amount of time attempting to predict it!

Everyone seems to have an opinion on the direction stocks will take, yet there are so many interconnecting factors (or opinions, or opinions of other people’s opinions!) that it seems foolhardy to even try.

John Maynard Keynes explained this well enough in 1936 with his beauty contest analogy and yet we have entire TV channels seemingly devoted to stock market fortune telling.

It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.
(Keynes, General Theory of Employment Interest and Money, 1936).

The only thing we can be certain about the future in relation to stocks is that the prices WILL CHANGE.

We will continue to experience both short and prolonged periods of escalation, decline and extreme valuations.

We will also on occasion (or perhaps frequently) be surprised by the markets direction. As J.P. Morgan once quipped when asked about what will happen with the prices of the stock market, ‘they will fluctuate’.

Famous hedge fund manager George Soros also had this to say on the subject.

The financial markets generally are unpredictable. So that one has to have different scenarios… The idea that you can actually predict what’s going to happen contradicts my way of looking at the market.

So why do we still pay any attention to stock forecasts? Why use complicated mathematics to predict the future? We all know that the past is not an indication of the future and yet using past prices to create mathematical models of future prices is acceptable practice?

I think the answer lies in a human’s desire for a good story and perhaps our desire to feel like we actually know what’s going on. We are constantly seeking reassurance.

This desire to explain every market movement can actually be detrimental to your investment performance.

Investment Manager Tim Price recently discussed this in an article on www.cobdencentre.org:

The irony is that most investors might be better served by cutting out the commentary altogether (an irony of which we are, of course, well aware). The psychologist Paul Andreassen showed that people who receive frequent news updates on their investments earn lower returns than those who get no news. The following is from a 2002 Fast Times article:  “The barrage of information and pseudo-information has been magnified by the explosion in financial news over the past decade. In the late 1980s, psychologist Paul B. Andreassen did a series of experiments with business students at MIT that showed that more news does not necessarily translate into better information. Andreassen divided students into two groups. Each group selected a portfolio of stocks and knew enough about each stock to come up with what seemed like a fair price for it. Then Andreassen allowed one group to see only the changes in the prices of its stocks. Students in that group could buy and sell if they wanted, but all they knew was whether the price of a stock had gone up or down. The second group was allowed to see the changes in price and was also given a constant stream of financial news that supposedly explained what was happening with each stock. Surprisingly, the less-informed group did far better than the group that was given all the news. “The reason, Andreassen suggested, was that news reports tend to overplay the importance of any particular piece of information. When a stock fell, its fall was typically portrayed as a sign that further trouble lay in wait, while a stock that was on the rise seemed to promise nothing but blue skies ahead. As a result, the students who had access to the news overreacted. Because they took each piece of information as excessively meaningful, they bought and sold far more frequently than the people who were just looking at the price.” – See more

Perhaps then, we need to consider that our desire to seek explanations for everything is damaging to our investment prospects and uncertainty should be more readily embraced.

It is worth reflecting on the fact that our very existence as human beings is uncertain. As outlined in Nassim Taleb’s excellent book Black Swan: The impact of the highly improbable, apparently the probability of us even being here is about 1 in 400 trillion.

That should put other risks and uncertainties into perspective.

By Mark Underdown

Financial Coach, Small Acorn Money

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