About The Absurdity Of Attempting To Predict The Future

About Intelligence, Soldiers and Monks

Humans tend to focus on improving the future for themselves in their lives, and for part of their next lives, the new generation, their children. The concept of the future is abstract and uncertain, comprehended only by those species who possess higher intellect. Future planning requires the ability of mental time travel to anticipate future needs. This involves willingly sacrificing immediate gratification in favor of potential long-term benefits — investing.

A few animals are able to do it. An experiment on squirrel monkeys found that they were willing to choose fewer peanuts initially if it meant that they would be rewarded with more peanuts later. In another example, a chimpanzee from a zoo in Sweden was continually observed storing stones to throw at human visitors later in the day when the humans came by. The chimpanzee only used the stones for this purpose; it did not store them during the off-season while the zoo was closed to visitors.

The tendency to invest differs greatly from person to person. It depends on 1) the shrewdness to implement the concept of the future into reality, 2) the ability to tolerate the associated risks, and 3) the subjective importance of present pleasure versus future improvement.

The Intelligent

The shrewdness to implement the concept of the future into reality, long-sightedness, strongly correlates with intelligence. A grandmaster chess player, thinking ahead 15-20 turns, will always beat a low-rated Patzer playing turn by turn. That’s, of course, in a game with limited information, not surpassing the perceivable. Intelligence is the first hurdle to take, and some will have to fail just by their genetics. The realization that training is essential for improving performance is the breeding ground for any athlete. It’s the first hurdle to take, albeit not the hardest for most human beings.

The Soldier

Without tolerating the associated risks and being willing to lose and learn, there’s nothing to gain from grasping the concept of the future. Things can fail, and they certainly will go wrong many times. Negative outcomes tend to scare some more than others. Many will flee rather than fight, despite their ability to implement the concept of the future. The ability to endure pain and accept suffering is important to execute the desired plan.

The Monk

Even if one is able to perceive the future and willing to take the risk, they might consciously decide that the present pleasures they would have to give up aren’t worth the chances of future returns. Historically, more people lean toward such thinking when there has been nothing to fear about in the recent past. Investing requires the voluntary and cognizant decision for the possible improvement of the future over the guaranteed pleasures of the present.

After fulfilling the necessary requirements, countless practical absurdities hold intelligent monk-like soldiers back from becoming profitable investors. Investing is a game with unlimited information. The past doesn’t predict the future, as new information emerges from nothingness, and existing information vanishes into insignificance. By attempting to perceive the imperceptible, it’s not a matter of if but when one will fail. We try to categorize the imperceptible, desperately attempting to grasp hold of the nothingness by focusing on a specific part of it. There are different categories for each prejudice — all of which are absurd.

The Absurdity of Value Investing

Value investing is one of the simplest methods, often the starting point for many investors. In theory, this method aims to exploit temporary differences in price created by supply and demand compared to the calculated real value of any given asset. An asset might be deemed overbought or oversold based on the disparity between its market price and perceived value. Price is objective and determined by the marginal buyer of the asset. However, the concept of value is inherently subjective. Various valuation methods exist, including discounted cash flow models, revenue, EBIT, and earnings multipliers, book value, among others.

Furthermore, subjective inputs to the above-listed valuation models result in wide deviations within the same model. In a typical discounted cash flow model, the free cash flow of the past is projected into the future, often linearly — sometimes degressively, sometimes progressively. Adjustments for future return growth can easily double or triple the perceived value. However, the biggest source of unreliability lies in the discount rate. The lower the discount rate, the higher the value due to the increased worth of future returns relative to the present.

For example, consider the results of a simple cash flow model projecting owner earnings of $100 from a company with a projected 5% growth rate over seven years. Depending on the discount rate (5-9%) and terminal value (-0.5-2.5%), the equity could be valued anywhere from $268.69 to $914.27. Quite a discrepancy.

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For each result in the table, there are infinite possibilities to argue for the correctness of the subjective value. Perhaps the company will go bankrupt in the next 10 years due to a new competitor, or maybe it will quadruple its earnings within the next two years thanks to the magical wand of artificial intelligence. The results can be bent in any direction at will by the assessor.

If you put a random amount of marbles into a glass jar and let people guess how many marbles are in the jar, most of them will be wrong. Some may be significantly off, while others might be closer to the correct amount. However, the median of all guesses is likely to be closer to the true amount of marbles than any individual guess. This concept, known as the wisdom of the crowd, also applies to financial markets. Today’s financial markets are highly efficient in most areas of investment, meaning that prices typically reflect perceived value. Any logically thinking person would not try to beat the median of the guesses by the crowd with his own prejudices, as it always represents a losing position.

Without a personal edge, such as insider information, claims of over- and undervaluations or opinions on whether an asset is ‘cheap’ or ‘expensive’ are simply signs of misunderstanding. While there are a few experts, typically employed in the specific field they invest in, who possess a real edge due to information advantages – essentially having counted the marbles beforehand – most investors lack these opportunities. Valuation metrics of any kind are inherently subjective, emerging from nothingness and vanishing into insignificance depending on the current disposition of value investors.

Value investing is absurd.

The Absurdity of Technical Analysis

After realizing that most prices have already discounted every available information and are therefore efficient, why not eliminate everything subjective and solely analyze the objective truth – the price? That’s what technical analysis aims to achieve.

Technical analysis comes in all kinds of different strategies just like value investing. While value investing seeks to capitalize on perceived irrational behavior by the median, aims to forecast high-probability future price movements by analyzing the objective past – the market price history. Therefore, technical analysis requires the humbling acceptance of subjective misjudgment of the objective past. Meaning: for every strategy there has to be an exit – a risk management tool for the event that the subject is wrong. Technical strategies are more advanced than value investing strategies in the sense that they accept the average losing proposition the single mind has against the hive mind.

History doesn’t repeat itself, but it rhymes – that’s true. However, the impossibility lies in objectively grasping the rhythm. Similar to value investing, there’s no inherent advantage in knowing the most basic strategies involving moving averages, Elliott waves, oscillators, relative strength, etc. These metrics alone are nothing to be systemized. With everyone having access to the same data, subjective prejudice plays a significant role. There is no difference between gambling and using simple technical analysis by its own without an edge. The simple mind falls into the trap of value investing trying to outsmart the objective, the gamblers fall into the trap of technical analysis deceiving themselves with objective data but really repeating the patterns of their addiction.

Proper risk management, gathering proprietary data, utilizing unique datasets, conducting thorough backtesting of strategies, and avoiding overfitting are crucial elements in developing a technical process that can yield superior risk-adjusted returns. However, creating such a process requires extensive research, investment of time, and a degree of luck. It’s the equivalent to using insider knowledge in value investing. For anyone without substantial funds or time, these processes are very likely to be entirely unrealistic.

Technical analysis is absurd.

Author’s Note: This is the first part of a two-part article titled “About The Absurdity Of Attempting To Predict The Future.” The second part will be released later in April 2024.

Jede Wirklichkeit, jede erfüllte Gegenwart, besteht aus zwei Hälften, Subjekt und Objekt. Bei völlig gleicher objektiver Hälfte, aber verschiedener subjektiver, ist die gegenwärtige Wirklichkeit eine ganz andere.

Every reality, every fulfilled present, consists of two halves, subject and object. With completely identical objective halves but different subjective ones, the present reality is entirely different.

Arthur Schopenhauer – Die Welt als Wille und Vorstellung / The World as Will and Representation