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Investors Therapy #17: Horses and Economic Forecasts

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Hey Investors, I hope everyone is doing ok out there during these troubled times. It's rough out ther
 

Investors Therapy

May 10 · Issue #17 · View online
Investors Therapy is a newsletter that helps investors understand their psychology so they can make smarter investment decisions. If you're ready to take the next step in your investment journey, subscribe!

Hey Investors,
I hope everyone is doing ok out there during these troubled times. It’s rough out there, so I wanted to jot down a few of my thoughts on COVID, your mental health, what’s going on in the economy, and investing. Feel free to share if you find it helpful.
Also, I wrote the following therapy session last year and didn’t have enough time to send it out. But it just goes to show how markets can turn on a dime from going from up and up and cash is trash, to an economic panic and doom and gloom. Markets are much more fragile than they seem and this is something you need to keep in mind when you make an investment.
Now lets get to today’s therapy session.
There Once Was a Horse Named Clever Hans
Hans was a special horse who seemed to have the ability to do math. You could ask Hans a simple math question, and he would provide you with the correct answer by clopping his hoof against the ground the exact right number of times. Once his talent was discovered, Hans developed quite a following, and eventually, Hans’ story was even featured in the New York Times.
Due to all of this fanfare, groups of researchers began to visit Hans to investigate how a horse could possibly be doing mathematics. Unfortunately, it soon became evident to the researchers that Hans wasn’t actually deducing anything; he was only reading the body language of his trainer as the man unintentionally reacted to the number of clops that Hans clopped out in response to the math problems posed by his visiting fans.
Hans’ real superpower, it turned out, was the ability to recognize nearly imperceptible changes in his trainer’s body language. As Hans clopped each clop, he would watch his trainer for the tiny micro-expressions and shifts in body language that signaled to him that he was approaching the correct answer. Then, when he saw certain other changes, he would stop clopping and give the impression that he was correctly solving math problems. Hans fooled hundreds of people into thinking that he could answer questions that he could not actually answer by learning to interpret the unintentional signals that his trainer was giving him.
Sadly, Hans wasn’t a math genius; he was just exceptionally good at reading body language. 
So why were people captivated by a horse that could do math?
To state the obvious, seeing a horse do math is captivating. Seeing such a feat adds a bit of magic into a post enlightenment world that is devoid of the enchantment that the old world was enmeshed in, such as thousands of gods, spirits, devils, and mysteries that helped our ancestors cope in an uncertain world. In our day and age, we live in a certain world, mostly everything is explained, rational, and devoid of spirit. If I need to know anything I go to wikipedia and get a mechanistic explanation of how things work. But when a certain world deals with uncertainty, we tend to strive for immediate order, and not accept the mystery of an uncertain future. So to rectify the problem of uncertainty, we look to others to tell us how things will enfold.
We have replaced our prophets with professionals
While we can laugh at folks who thought that a horse could do mathematics, we tend to take seriously economists, financial analysts, and hedge fund managers who claim to foresee the future. Unfortunately, the economy isn’t static; it’s a dynamic system that’s in constant motion and full of ambiguity. This makes it impossible to predict exactly what will happen next.
When times are good in the economy, we’re constantly on the lookout for potential dangers. This is a smart thing to do. But too much fear can cause investment paralysis and foregone opportunities. As an investor, you must be flexible, and you need to make peace with the fear of investing because you won’t earn a premium on your investment if there isn’t uncertainty. As soon as something becomes common knowledge, investments become priced nearly to perfection, and there’s no longer any true value to be had.
So how can we cope with this uncertainty?
We tend to listen to those of us who claim to know the future. Because we seek answers to the questions in this uncertain world, we are hungry for stories about forecasts that allow us to peer into the future, and the forecasters who make them. It’s easy and profitable to make these forecasts because if you’re right, then you can write a book or launch a hedge fund and make quite a bit more money; but if you’re wrong, then your prediction will be lost to history among the pages of other failed predictions. Forecasters have basically nothing to lose.
Being that the majority of predictions are wrong, why do we gravitate towards them?
Predictions soothe our feelings in the following ways:
  • Being around someone who seems smart and knows the future makes us comfortable. We feel like someone we trust can turn our chaotic future into something much more predictable. It lifts the burden of uncertainty off of our shoulders, relieves us from thinking, and lets us move on.
  • Predictions can allow us to minimize or ignore our investment due diligence because we believe that an economic forecast will bail out our investment strategy. If a forecaster foresees a real estate bull market, you’ll think that you can purchase any piece of property and do well in the market.
  • When forecasters are wrong, it allows us to point the finger at them when our investment theses fail, and then they can become our economic scapegoats. This allows us to relieve ourselves of the responsibility of making poor investment decisions.
  • Predictions provide us with a sense of control and make the economic world seem more manageable.
As Walter Benjamin once said, “He who asks fortune-tellers the future unwittingly forfeits an inner intimation of coming events that is a thousand times more exact than anything they may say.”
What this esoteric quote is saying, is that we need to stop robbing ourselves of our personal power by looking for solace in forecasts and predictions. Realize that no one can truly predict what will happen with the macro economy, or, more importantly, know exactly when exactly an event will happen. It’s better to focus your attention on your surrounding environment and determine what investment opportunities you can take unique advantage of and to not take risks or make investments that, if they blow up, will take down your finances completely because you don’t want to find yourself chasing clever horses.
 
Cheers,
Jordan
 
P.S. - As always, this is an open therapy session, so if you know of a friend who needs help, then please share this newsletter with them!

Hans makes his first economic forecast
Hans makes his first economic forecast
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