Prediction machines

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It’s easy to make predictions, but making them useful is another matter entirely

Everything is alive make predictions by filtering information from the surrounding world. We humans are constantly making predictions, no matter how far you need to move your finger to scratch your nose or to avoid getting hit by a car.

We are prediction machines and often find shortcuts. How often do you predict when you will be able to cross a busy road, not by waiting for the green man, but by watching to see if the traffic light is orange? Or, if the lights are not visible, does traffic slow down in response to the orange light? And, yes, we also know that a car’s speed can be the first sign that the light has just turned from green to orange.

We predict constantly, without thinking and intelligently.

Making predictions is at the heart of the investment business. Active fund managers make predictions about the future prices of markets, stocks, etc., either directly – technical analysis – or indirectly – fundamental analysis. When you as an individual investor buy a passive fund, you are predicting, whether you know it or not, that it will perform a certain way.

By the way, in connection with this last point, I wrote several years now on how the performance of passive balanced funds may deteriorate as bonds, one of the two main components, become very expensive.

Rising inflation over the past 15 months or so has only made things worse for balanced funds. This pushed up stock and bond yields, causing nominal prices to fall, but it also caused those poor to fall nominal returns to be even worse are real terms, a double whammy. If inflation remains high or increases in the coming years, this poor performance will continue.

But I digress.

Some predictions are as good as they are useless. I’m not going to get a lot of credit by predicting that the sun will rise tomorrow. And predicting the opposite isn’t very helpful either – in the unlikely event that I’m right, praise will be in short supply. Making predictions where the probabilities are actually 0 or 100 percent isn’t fair – you need to stick to the middle where there’s uncertainty.

However, uncertainty alone is not enough to give a forecast merit. I’m not going to make money over time by predicting which side an unbiased coin will land on. why? Because a 50% chance will always be 50% and that’s it knows they are 50% Do money uncertainty is needed from prediction in conjunction with good reason to think the odds are wrong, advantage.

In skill betting and investment markets, market odds are expressed either explicitly as odds – for example four to one, which is equivalent to a 20% probability – or implicitly as prices – Unilever’s current price tells you that in general expected about his future. Indeed, it was mathematically proven to maximize your winnings over time, your bet/position size as a percentage of your wallet/portfolio should be edge divided by foran edge is a measure of the difference between the market probability of an outcome and your own probability of it.

An advantage can be either some specialized experience/ability or inside information. Examples of the former would be algorithms written by mathematical geniuses and running on a very fast computer, or the ability to accurately gauge the emotions that drive markets rather than obeying them. As for using inside information, your return may include a Wandswart spell nickname.

Predictions that no one listens to can be useless at worst and futile at best. According to UCLA professor Albert Mehrabian, only 7% meaning is conveyed through what you say Most passed how you say it – tone of voice, body language, etc. The predictions of a fund manager or research analyst are only useful to an employer if they help generate profits. Predictions that are not supported by credible evidence or intellectual support are also generally not accepted by people, except for conspiracy theorists.

As someone whose job it is to make predictions, I feel that I have a responsibility to both myself and my audience to revisit past predictions as well as repeat current ones. There is little responsibility for forecasting in the investment industry; the term “two cents worth” is a reference to an opinion that is not worth very much. Financial media know that viewers and readers are much more interested in what people think will be what happened was not what they thought would will happen

Having said that, here is a summary of my current predictions, all of which have been laid out in previous blog posts – clarity of communication is important. In the next post I will also evaluate my past predictions – accountability and humility are also important.

Over the next few years, I think inflation will come down, but then it will rise again and remain high for a few years. Inflation will decline over the medium term as a result of a recession caused by real incomes squeezed by high inflation no longer being able to support the economy. In other words, like others argued, the best cure for high prices is … high prices. Higher interest rates will also weaken demand.

Some newsletters noted that if there is a recession, it will be the most expected ever. The significance of this is that there has been no recession since then yet, the predictions of this must be wrong. I’m not sure I completely agree with that. In 2007, it was very clear that the difficulties in the financial markets – subprime etc. – may worsen even more and affect the real economy. They did. A year later and a little later.

It also assumes that things are linear on the economic front, meaning that if things only get slightly worse like they are now, they won’t get too bad and will turn around at some point.

This is not always the case. Economies are an example complex nonlinear adaptive systems. They reach tipping points, when things that have only been changing slowly suddenly deteriorate rapidly. Consumer spending on non-essential goods in many countries has started to fall, but only gradually. It’s not hard to see that at some point credit cards are maxed out, consumer spending starts to fall faster, causing wider fears among consumers and companies, and the downward spiral continues. Tipping point and recession.

Although it would undoubtedly be painful for many, a recession would not be a bad thing, as the reduced demand would help reduce inflation. Indeed, the decline from a a purely economic perspective should be seen as a remedy for high inflation which is itself a symptom of some underlying problem or disease – Zimbabwe, Turkey, Argentina, etc. are examples of an emergency.

However, recession only treats the symptoms, it does not necessarily treat the underlying disease. There is reason to believe that the underlying problems in the global economy are now such that after a recession and a period of deflation, inflation will rise again and remain high for several years. Really, that’s what I’m waiting for.

The current high inflation is undoubtedly the result of supply problems related to COVID-19 and Ukraine, as well as excessive fiscal policy in the US, which has pushed up prices everywhere – we live in an interconnected world. In addition, the effect of companies seeking to make supply chains more secure by returning production from lower costs in developing economies is to push prices even higher. We’ve also started to see so-called second-round effects, namely wage acceleration.

Moreover, the Russian invasion of Ukraine may have ushered in a new era of geopolitical risk, in which persistently high/rising food, energy, and metals prices could affect consumer prices more broadly. I also fear that the bloated balance sheets of central banks make them less able to manage inflation, as they have done quite well over the past forty years.

My big prediction in recent years has been that “safe haven” bonds will turn out to be dangerous. I may have been a bit early, given that they performed well in the early stages of the pandemic. However, this was short-lived, and real safe-haven bond prices are now lower than they were before the pandemic and even the majority periods to date over the past ten years.

The good news is that for investors whose portfolios are still heavily exposed to so-called safe-haven bonds, the recession will do well in the next year or two. However, this should be seen as an opportunity to sell them – in other words, a second bite of the cherry rather than a cause for celebration.

The opinions expressed in this post are those of Peter Alston at the time of writing and are subject to change without notice. They do not constitute investment advice and, although every reasonable effort has been made to ensure the accuracy of the information contained in this communication, the reliability, completeness and accuracy of the content cannot be guaranteed. This communication contains information for professional use only and should not be used by retail investors as the sole basis for investment.

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