Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 357

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.

 

RELATED ARTICLES

Five timeless lessons from a life in investing

Five factors driving the great Australian recovery

Four themes to set your portfolio for economic recovery

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Australia’s bounty: is it just diversified luck?

Increases in commodity prices have fuelled global inflation while benefiting commodities exporters like Australia. Oftentimes, booms lead to busts and investors need to get the timing right on pricing cycles to be successful.

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Latest Updates

Investment strategies

Five features of a fair performance fee, including a holiday

Most investors pay little attention to the performance fee on their fund but it can have a material impact on returns, especially if the structure is unfair. Check for these features and a coming fee holiday.

Interviews

Ned Bell on why there’s a generational step change underway

During market dislocation events, investors react irrationally and it should be a great environment for active management. The last few years have been an easy ride on tech stocks but it's now all about quality.  

SMSF strategies

Meg on SMSFs: Powers of attorney for your fund

Granting an enduring power of attorney is an important decision for the trustees of an SMSF. There are alternatives and protections to consider including who should perform this vital role and when.

Property

The great divergence: the evolution of the 'magnetic' workplace

The pandemic profoundly impacted the way we use real estate but in a post-pandemic environment, tenant preferences and behaviours are now providing more certainty to the outlook of our major real estate sectors.

Shares

Bank reporting season scorecard May 2022

A key feature of the May results for the banking sector was profits trending back to pre-Covid-19 levels, thanks to lower than expected unemployment and the growth in house prices.

Why gender diversity matters for investors

Companies with a boys’ club approach to leadership are a red flag for investors. On the other hand, companies that walk the talk on women in leadership roles perform better, potentially making them better investments. 

Economy

Is it all falling apart for central banks?

Central banks are unable to ignore the inflation in front of them, but underlying macro-economic conditions indicate that inflation may be transitory and the consequences of monetary tightening dangerous.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.