The Illusion of Knowledge

Key Highlights

• “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” - John Kenneth Galbraith
• The memo touches on Marks’ disbelief in forecasts, classifying them as rarely helpful
• “The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge” - Daniel J. Boorstin
• A model simply can’t replicate something as complex as an economy
• Stationarity: An assumption that the past is a statistical guide to the future, based on the idea that the big forces that impact a system don’t change over time.
• Stationarity is a wonderful, science-based concept that works right up until the moment it doesn’t
• Noted physicist Richard Feynman once said, “Imagine how much harder physics would be if electrons had feelings”
• Thus for me, the bottom line is that the output from a model may point in the right direction much of the time, when the assumptions aren’t violated. But it can’t always be accurate, especially at critical moments such as inflection points… and that’s when accurate predictions would be most valuable.
• 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.
• So, is this a call to greater action?
• Clearly, no forecast can be better than the inputs on which it’s based.
• Consider for a moment what we are implicitly asking when we pose the question: Has inflation peaked? We are not only asking about the supply of and demand for 94,000 different commodities, manufactures and services.
• We are also asking about the future path of interest rates set by the Fed, which – despite the much-vaunted policy of “forward guidance” – is far from certain. We are asking about how long the strength of the dollar will be sustained, as it is currently holding down the price of U.S. imports.
• But there’s more. We are at the same time implicitly asking how long the war in Ukraine will last, as the disruption caused since February by the Russian invasion has  significantly exacerbated energy and food price inflation. We are asking whether oil- producing countries such as Saudi Arabia will respond to pleas from Western  governments to pump more crude. . . .
• I think accurately predicting inflation is “more impossible” (if there is such a thing) than predicting the outcomes of the other two
• I imagine that for most money managers, the process goes like this: “I predict the economy will do A. If A happens, interest rates should do B. With interest rates of B, the stock market should do C. Under that environment, the best performing sector should be D, and stock E should rise the most.” The portfolio expected to do best under that scenario is then assembled.
• Remember that E is conditioned on A, B, C and D. Being right two-thirds of the time would be a great accomplishment in the world of forecasting. But if each of the five predictions has a 67% chance of being right, then there is a 13% probability that all five will be correct and that the stock will perform as expected.
• Doesn’t this question indicate an insoluble feedback loop: To predict the overall performance of the economy, we need to make assumptions about, for example, consumer behavior. But to predict consumer behavior, don’t we need to make assumptions regarding the overall economic environment?
• It’s circular
• “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” - Mark Twain
• In the 1970s we used to describe an economist as “a portfolio manager who never marks to market”
• Can you imagine hiring a money manager (or being hired, if you are a money manager) without reference to a track record?
• The world seems incredibly short on information regarding the value added by macro forecasts, especially given the large number of people involved in this pursuit.
• Faulty Fed forecasts resulted in faulty forward guidance and increased financial market volatility.
• If I don’t do it, I won’t be able to attract clients.
• Since investing consists of positioning capital to benefit from future events, how can anyone expect to do a good job without a view regarding what those events will be? We need forecasts, even if they’re imperfect.
• I’ve been waiting  for an opportunity to write about my favorite sub-headline from the issue dated October 30, 1929, which followed two days on which the Dow Jones Industrial Average declined by a total of 23%. It read, “Bankers Optimistic.” (Less than three years later, the Dow was roughly 85% lower.).
• Most bankers – and most money managers – seem to be congenitally optimistic about the future. Among other things, it’s in their best interests, as it helps them do more business. But their optimism certainly shapes their forecasts and their resulting behavior.
• Maybe in Venture Capital, the idea is to be a rational optimist and certainly think optimistically - but don’t let your optimism cloud your judgement
• “I think the Fed will remain very worried about inflation and thus will raise rates significantly, bringing on a recession. So I’m in risk-off mode.” Another said, “I foresee inflation moderating in the fourth quarter, allowing the Fed to turn dovish in January. That will allow them to bring interest rates back down and stimulate the economy. I’m very bullish on 2023.”
• The truth is that humans can hold only a few things in their minds at any given time. It’s hard to factor in a large number of considerations and especially to understand how a large number of things will interact (correlation is always the real stumper).
• In 2016 Buffett shared with me his view of macro forecasts. “For a piece of information to be desirable, it has to satisfy two criteria: It has to be important, and it has to be knowable.”
• But I agree strongly with Buffett that the macro future isn’t knowable
• Late Stanford behaviorist, Amos Tversky: “It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on.”