Reading the Last Page First

"Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important." -- Warren E. Buffett, 2013 Berkshire Hathaway Shareholder Letter

For the better part of my early career as an economist and investment strategist, it was my job to offer up the annual outlook. After publishing the outlook, I would have to spend the remainder of the first quarter talking about it. It wasn't a part of the job that I enjoyed much. It always seemed rather pointless, as it was weeks until companies would report their year-end financials, let alone begin to offer their outlooks.

The reality is, economic and market predictions are no more than guesses, and often foolish ones at that. The most foolish are based on so-called historical "facts," such as the market's average performance in the second year of an election cycle, whether the Superbowl champion is from the AFC or NFC, or what astrological year it is. These might be fun coincidences, but ultimately none of these "facts" have any bearing on how well economies and stock markets perform.

Not only does forecasting the market seem an odd thing to do simply because the calendar turned, but also since study after study has shown that not only are people generally not good at it, but neither are professional analysts.

So try as I might to couch my outlooks as economic & market perspectives, many readers still flipped to the last page to see what was predicted - what I referred to as "reading the last page first" problem. In essence, it was the prediction that was valued more than the perspective, in spite of the known foolishness of market predictions.

"Worldy wisdom teaches us that it is better for reputation to fail conventionally than to succeed unconventionally." -- John Maynard Keynes

John Maynard Keynes described this penchant for foolishness among professional investors nearly 80 years ago. He did this by relating the behavior seen in newspaper “beauty contests” at the time. In these contests, readers were asked to choose the six “prettiest” faces from a set of one hundred photographs. The winners were those whose choices were the most popular among everyone.

Keynes reasoned there were several possible strategies, from the naïve, to the sophisticated. A naïve strategy was to simply choose the six “prettiest” faces. An advanced strategy was to anticipate the public's perception of "pretty." A sophisticated strategy took this a a step further, selecting the "prettiest" by “anticipating what average opinion expects the average opinion to be.” Of course this process can go on forever, but you can see the problem developing - your definition gets so contorted by the goals of the contest, that what's truly pretty to you is no longer meaningful.

Specific to investing, this same behavior leads investors to act based on others' objectives. Just as with popularity contests, what's given top priority is the opinion of others, while its counterpart - risk - gets defined as deviating from what the consensus thinks.

Many of today’s market participants, inclusive of professional money managers, have grown up in an era where "investing" is viewed little different than gambling. The reasons for this are numerous, but taken together result in the popular view that stock price changes are entirely random. What this view, and its associated behavior underscores is that much of the investment community lacks well-defined investment objectives, with the defaults being to “beat the market” and to "not lose money.” Understanding fundamental factors, let alone what a company does and how it does it, usually doesn't rate all that high on the decision tree of investing. Instead, decisions become motivated by an investment’s price, and attempting to outguess what the consensus thinks the consensus' price expectation will be in the future - what amounts to pure speculation.

Achieving true investment success, first requires defining a successful objective. For most, objectives are slow moving targets in the future, particularly when compared to the speed of financial markets. Similarly, the real value of investments changes slowly and measurably, irrespective of volatile share prices, which can move rapidly as focus shifts from the distant future to the immediate issues of today. What's lost ultimately, is the purpose of investing -- which is so simple, but also easily forgotten -- to lay out today's savings in order to attain more "tomorrow."

The unfortunate consequence of investing without a real objective, is to fall prey to the notion of investing to "win" -- getting caught up in the frenzied buying when prices are rising (fear of not winning) and selling when prices are in decline (fear of losing), and a multitude of in-between behaviors that virtually assure losing, or at best, achieving mediocrity. History has demonstrated that disciplined investors, with clear objectives, have a reasonable chance of achieving long-term success, whereas speculators are merely likely to lose money over time.


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