Let’s now consider the second bullet point. In order to produce something useful, one must have a reliable method, i.e., a repeatable process that’s capable of converting certain inputs to a desired output. Our issue with predictions, e.g., macro forecasts, is that there are simply too many interconnected and volatile variables which make coming up with a useful signal impossible. In light of all these complexities, macro forecasters are forced to make several assumptions such as analyzing economic factors in the aggregate, or only for a select group or market. There’s no way to predict the future that doesn’t require the making of assumptions.
Inconveniently, while small errors in these assumptions can lead to different outcomes, random exogeneous events can derail everything at once. A prime example of randomness is the Covid-19 pandemic which caused much of the economic world to shut down and triggered massive fiscal spending. It was impossible to anticipate the pandemic, let alone its financial impact. Good luck putting all of this together and disentangling the Spaghetti. Nassim Taleb calls people who do it “macro bullshitters” in this Odd Lots podcast.
Forecasts create the mirage that the future is knowable.
Somewhat unsurprisingly, while macro forecasters are eager to bombard us with their predictions for a fee, rarely, if ever, do they mark-to-market. People who mark-to-market have skin in the game, take risks, and own the P&L of their decisions – a macro hedge fund, for instance. Like us, these funds are in the business of making money as opposed to sharing predictions widely with the outside world. Clearly, any sustainable edge in the markets is too valuable to be given away for free on X, formerly Twitter, or through a newsletter.
Moreover, when people don’t mark-to-market, they can get away with being wrong. Can you imagine hiring an investment manager without reference to a track record? Probably not. But macro forecasters without real track records are hired all the time. That’s because they have a great “trick” up their sleeves, essentially a free option: If the prediction didn’t come true, the forecaster can roll the dice again without suffering any direct financial consequences, and sway clients by
- selectively recalling correct forecasts from the past, especially bold ones
- over-emphasizing predictions which turned out correct, and discounting or minimizing those which didn’t materialize
- focusing on the huge opportunities that lie ahead, usually without stating an exact time horizon over which these opportunities are expected to pay out, or using an ultra-long-time horizon (during which anything can happen)
- selectively benchmarking against others (we still did better than “them”)
- saying that unsuccessful forecasts were unfairly impacted by random events which nobody could have seen coming
At Takahē Capital, we accept that we don’t and cannot know the future. Markets are second-order chaotic systems with feedback loops that actively respond to predictions. The dynamics of these systems are impossible to forecast. Therefore, making predictions about market prices is pointless.
The good news is that we don’t have to know the future to be successful as traders. In fact, it is our mission to grow our investors’ capital in the absence of any knowledge about the future.
It is an iron rule of history that what looks inevitable in hindsight was far from obvious at the time.
Yuval Noah Harari
Although our systems use historical price data as inputs, it does not mean that what has happened in the past is predictive of what might happen in the future. The future will never be an exact replay of the past. There may be similarities, but there is never an exact parallel.
It's frightening to think that you might now 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.
Fortunately, a feature that doesn’t depend on past price data is our “superpower” of keeping losses small while letting winners run on. Rather than attempting to foretell an unknowable future, trend following strategies determine the path of least resistance and take small probing bets in the direction of price movement. This is what protects our core capital; this is how we cope with the many curveballs the markets throw at us; and this is how we cope with emotions and biases, allowing us survive as traders in the face of uncertainty.