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Howard Marks on uncertainty, forecasting and doubt

Howard Marks is Co-Chairman of Oaktree Capital Management, and we have featured several extracts from his memos to clients to help understand how a global leader is investing during a pandemic.

This is a summary of his latest memo dated 11 May 2020, titled simply 'Uncertainty'.

 

Like many of us, Howard Marks has been at home for two months. It has given him plenty of extra time to be philosophical about markets, and it is reflected in a memo which poses more questions than answers.

He admits with some frustration that many economic forecasts vary significantly when presented with exactly the same facts and assumptions. He quotes economics consultant Neil Irwin:

“The world economy is an infinitely complicated web of interconnections. We each have a series of direct economic interrelationships we can see: the stores we buy from, the employer that pays our salary, the bank that gives us a home loan. But once you get two or three levels out, it’s really impossible to know with any confidence how those connections work.”

And Ian E Wilson, former Chairman of GE:

“No amount of sophistication is going to allay the fact that all of your knowledge is about the past and all your decisions are about the future.”

We all have in-built biases

Marks acknowledges there are some things we know for certain about the future, such as the trend to shopping online, but since everyone is aware of the change, it does not help in the pursuit of extra returns. Most forecasts are mere extrapolations of recent trends and are already built into prices.

The conundrum is that while forecasts are unlikely to create above-average returns, all investors like to frame their buying and selling into some macro picture of the future. The investment industry thrives on making a vast amount of forecasts which clients devour.

Marks says our views of the future reflect our biases:

“One of the biggest mistakes an investor can make is ignoring or denying his or her biases. If there are influences that make our processes less than objective, we should face up to this fact in order to avoid being held captive by them. Our biases may be insidious, but they are highly influential.”

We should all reflect on how we consume news and absorb gleefully the views that confirm our biases. We all seek confirmation biases. Marks quotes Shahram Heshmat in Psychology Today:

“Once we have formed a view, we embrace information that confirms that view while ignoring, or rejecting, information that casts doubt on it. Confirmation bias suggests that we don’t perceive circumstances objectively. We pick out those bits of data that make us feel good because they confirm our prejudices. Thus, we may become prisoners of our assumptions.”

The best example in global news is the Murdoch empire including Fox News. Those who embrace its right-wing views feel affirmed by the authority of its presenters, including in Australia, Andrew Bolt, Alan Jones, Peta Credlin and Chris Kenny. They often have strong opinions on climate change, Donald Trump and nationalism that their audience loves. Their programs are watched by people who want their views affirmed, and generally ignored by people who disagree with them. Most people are also drawn to reading one newspaper, say The Australian versus The Sydney Morning Herald, and the political and social emphasis in the respective letters to the editor clearly reflect this.

So it’s difficult to be objective and open to opinions from all perspectives.

Marks goes as far as saying that excessive trust in forecasting is dangerous. We need to admit to uncertainty, investigate before we invest and proceed with caution. At the same time, to outperform the market requires a departure from the crowd. Great investments begin with discomfort, since the market is usually avoiding them. It also takes resolve and confidence to hold a position when it declines, until it eventually becomes a winner. Or not, as investors must also decide when they have made a mistake.

Intellectual humility

Marks dwells in this memo on the concept of ‘intellectual humility’ and its impact on decision-making abilities in politics, health and elsewhere. It is similar to open-mindedness, where people with strong beliefs recognise their fallability and are willing to be proven wrong.

He says people with a view of the future should also assign a probability that their opinion will be correct. Not all predictions are equally likely and should not be relied upon to the same extent. Anyone who is sure about what will happen is probably deceiving themselves. He adds:

“To put it simply, 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.”

In fact, experts should not only know about their subject, but the limits of their knowledge and expertise. In the pandemic, the experts are not sure because they know it is reasonable to disagree on the best policies to pursue. We should be wary of supreme confidence. As medical statistician, Robert Grant, said:

“I’ve studied this stuff at university, done data analysis for decades, written several NHS guidelines (including one for an infectious disease), and taught it to health professionals. That’s why you don’t see me making any coronavirus forecasts.”

Amusingly, Marks writes that incompetent people have a double disadvantage, not only because they are incompetent, but they are probably unaware of it. How many amateur epidemiologists have surfaced in the past couple of months? True experts should express themselves by acknowledging the limits of their knowledge.

And so Marks concludes (to quote him):

  • The world is more uncertain today than at any other time in our lifetimes.
  • Few people know what the future holds much better than others.
  • Investing deals entirely with the future, meaning investors can’t avoid making decisions about it.
  • Confidence is indispensable in investing but too much of it can be lethal.
  • The bigger the topic (world, economy, markets, currencies and rates) the less possible it is to achieve superior knowledge.
  • Our decisions about smaller things (companies, industries and securities) have to be conditioned on assumptions regarding the bigger things, so they, too, are uncertain.
  • The ability to deal intelligently with uncertainty is one of the most important skills.
  • We should understand the limitations on our foresight and whether a given forecast is more or less dependable than most.

 

Graham Hand in Managing Editor of Firstlinks. Howard Marks has written regular memos to his clients and they can all be accessed here.

 

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