I couldn’t let this one go today, folks…
A headline on The Australian’s website reads, ‘The RBA flags the end of certainty’. The opening paragraphs explain:
‘Australia has entered an uncertain chapter of its economic history, marked by meagre wage growth, intense global competition among retailers, high household debt and elevated house prices, the Reserve Bank governor has declared.
‘In a speech in Sydney last night, Philip Lowe said automation and growing competition from foreign workers were sapping workers’ wages — now growing at their slowest pace in 50 years — and dragging down prices in ways that had confounded the Reserve Bank’s economists.
‘“We are still trying to understand this,” Dr Lowe conceded, revealing confusion at the top of the nation’s peak economic establishment that has already enveloped its counterparts in Europe and the US.’
At face value, that all sounds fine.
But if you think about the premise for 10 seconds — that we are heading into a period of uncertainty — it’s absurd.
The future is always uncertain. Sometimes you might feel like there is more certainty around than there is, but that’s just an illusion.
No one knows what’s going to happen tomorrow, next week, next month, or next year. The further out you go, the greater the uncertainty.
While we understand this on a deeper level, we reject it on an automatic thinking level. It’s just much easier to cope if we think we know what is going on.
And we think we know what is going on because we rationalise what has happened in the past with the benefit of hindsight. But at the time, we really had no idea how things were going to unfold.
As Danny Kahneman wrote in Thinking, Fast and Slow:
‘The illusion that one has understood the past feeds the further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety that we would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. We all have a need for the reassuring message that actions have appropriate consequences, and that success will reward wisdom and courage.’
Nicholas Nassim Taleb’s classic Fooled by Randomness is predicated on the same principle.
Go back and read the original quote, with Kaheman’s words in mind…
Do you feel a slightly heightened level of anxiety, having the illusion of understanding or certainty revealed for what it is?
When it becomes apparent that you really don’t understand what’s going on, it’s a cause for concern. That’s because we comfort ourselves by pretending we know. We create a ‘narrative’ for how we see the world, and act — and invest — accordingly.
This is where the connection with investing comes into it.
When you understand that you don’t really know anything, or have any strong convictions about what is going to happen in the future, you become a better investor. You’re more flexible and are open to a range of different (potentially money making) ideas.
It’s only when you have created a definitive narrative about how the world will unfold that you can get into real trouble.
Take the bears. They’ve been saying for years that the market is about to crash again, or that the economy will implode because we didn’t resolve the issues from the last crisis, we only papered over the cracks with more debt.
That may be true, but the market had other ideas.
If you’re stubborn about your narrative, you sit on the sidelines for years, watching everyone else make money.
After a while, you finally start to see what others apparently saw years ago, and you get back into the market. You feel comfortable. You’re not as scared as you once were. Your narrative is changing.
But you fail to realise that you’re one of the last to arrive at the party. That’s because the narrative that everyone else has been running with for years is new and exciting to you.
The thing is, at this point, you’re one of the final ones to buy. Then the market starts to fall and you don’t know what to do. Cognitive dissonance kicks in.
This is an extreme example. But I use it to illustrate how dangerous it is to have preconceived biases and narratives about the way the world is. They are very hard to change. And they often change at the wrong time.
When you know that you don’t know, you give yourself permission to change your mind…to go with the flow. If you want to be a better investor, going with the flow is crucial.
So, the takeaway for today is this:
Understand that you don’t really know anything. The future is unknowable. Uncertainty is always around. It’s just that sometimes the market prices uncertainty differently. It succumbs to the illusion of certainty in bull markets, and recognises it acutely in bear markets.
Have a view, but don’t be stubbornly wedded to it. Be willing to change your mind. Don’t worry about what you think. Worry about what the market thinks.
What is the market thinking now?
I don’t really know…but it seems to be pretty certain about how things will play out on a global scale. It’s certain that bitcoin and blockchain will take over the world, along with Amazon, Facebook, Apple and Netflix.
The market could well be right. But too much certainty means too high prices. And that’s a worry.
Editor, Crisis & Opportunity