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Don’t trust anyone who is certain about the future

It’s a mistake we all make, but it’s still a mistake.

If you watch the evening financial news or listen to daily business radio shows, you will be given the comforting idea that there is always an explanation for whatever happens in the markets. Whether it’s the stock market going up or the rand going down, or neither doing very much, the pundits always have a reason.

This is not just because those who believe themselves to be experts never want to admit that they might not always know why markets behave the way they do. It is our human nature to create coherent stories from what we see, and we do it all the time without knowing it.

Nassim Taleb, author of The Black Swan: The Impact of the Highly Improbable, calls this the narrative fallacy; our impulse to assign reasons for everything that happens, even when the evidence is flimsy. This is how we make sense of the world – we are faced with so much information that we need to put it in some sort of order to be able to process it.

In simple matters, this is important. If your hand is burning because it’s too close to the fire, it’s critical to realise that cause and effect. In more complex matters, however, its accuracy erodes.

The roll of the dice

Our minds also revolt against the idea that chance and luck play an extremely large role in how the world works. In his book – Thinking, Fast and Slow – Daniel Kahneman, one of the fathers of behavioural science, uses the example of the incredible success of Google to illustrate this.

The story most often told, and most easily believed, is that Google’s founders are visionary geniuses who turned a new idea about how to search for information on the internet into one of the most valuable companies in the world. This narrative details how Larry Page and Sergey Brin made brilliant business decisions and developed a culture within the organisation that explains their ultimate success.

“Unfortunately,” Kahneman writes, “there is good reason to believe that your sense of understanding and learning from the Google story is largely illusory. The ultimate test of an explanation is whether it would have made the event predictable in advance.

“No story of Google’s success would meet that test, because no story can include the myriad of events that would have caused a different outcome.”

Without diminishing Page and Brin’s accomplishments, there were many possible things that didn’t happen, and many times when bad luck could have disrupted their business, but didn’t. These are simply unknown, and nobody, including the founders themselves, could have foreseen the outcome. Luck and chance played an enormous role.

Humans, however, don’t like that idea. We far prefer to believe the story that Google succeeded because of Page and Brin’s incredible foresight, and the company’s entire evolution can be explained that way. Since it turned out a certain way, we see that as inevitable.

It’s an illusion

Kahneman calls this the ‘illusion of understanding’ – our predisposition to build stories from the information available to us. And the better the story is, the more likely we are to believe it.

This doesn’t, however, just shape our view of the past. As Kahneman notes:

“The core of the illusion is that we believe we understand the past, which implies that the future should also be knowable.”

This is where things get dangerous, particularly for anyone listening to people like financial pundits. Because if we can assign reasons to everything that happened in the markets today, then that means we must be able to predict how they will behave in future. We believe we can see patterns of cause and effect.

“The idea that the future is unpredictable is undermined every day by the ease with which the past is explained,” Kahneman writes. “As Nassim Taleb pointed out in The Black Swan, our tendency to construct and believe coherent narratives of the past makes it difficult for us to accept the limits of our forecasting ability.”

Humans, however, have been shown time and time again to be extremely poor at predicting the future. There is perhaps no more devastating proof of this than Philip Tetlock’s 20-year study of 284 experts, who he asked to make more than 80 000 predictions on global events. Their forecasting ability turned out to be worse than random.

Telling a tale

Studies like Tetlock’s (and there are many), have not however stopped the media and people in general from seeking out expert predictions. On the contrary, there is a whole class of people who make a lot of money from giving forecasts, whether about politics, technology, finance or even sports.

And the more confidently they deliver those forecasts, the more likely they are to be believed. Certainty is seen as a sign of expertise, but is really mostly a function of having a good story.

“Overconfident professionals sincerely believe they have expertise, act as experts and look like experts,” notes Kahneman.

“You will have to struggle to remind yourself that they may be in the grip of an illusion.”

The world, Kahneman reminds us, is unpredictable. Chance and luck play a far bigger role than any of us like to acknowledge. That is worth remembering when any ‘expert’ insists that a particular asset class is undoubtedly going to perform in a certain way, or that a particular market is facing an inevitable outcome. Just because they have a good story to go with their prediction, doesn’t mean they will be right.

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Prediction: prices for almost everything will rise

Some more predictions:

1. No action will be taken against Malema for his utterances.
2. The cadres will carry on stealing and being incompetent.
3. The NHI will fail.
4. The rand will depreciate over the long term.

Great article Patrick. The narratives we construct in an effort to make sense of what is happening around, bias us in the decisions we make about the future.

I like this article. Especially the way it relates to the markets.
You do research (or pay someone to advise you), decide to buy a stock, wait for the “right time” and enter the market.
What happens next relies a lot on luck…
Some people have systems to play roulette, dabble in forex or buy lotto tickets. There’s not much difference.
I’m not saying the markets are just a gamble – there are many factors to consider but we’d be arrogant to think that luck does not come into it in a big way.

Guess the Japanese rice traders in response saw the need to eliminate fundamentals and emotions and came up with rules based technical analysis using candlestick analysis to try and predict the future movement of the price of rice.

They have been strangely successful for an extended period of time.

Let me make one prediction: under the ANC the slide into collapse will not stop soon, if ever. Care to comment Patrick?

Excellent example. There’s probably around a 50% chance that you are right.

With regards to the ANC, I’ll haul out the old phrase: “The best predictor of future behavior is … past behavior”. In fact, I’ll go one further. Past and Present behavior. The ANC’s is dogmatically clinging on to socialist policies that have never been successful anywhere, ever, resulting in hardship and suffering. For the foreseeable future, I’m afraid, you don’t really need to be a profit to predict SA’s trajectory as long as the ANC is still in power. I see them being in power for some time to come, albeit at the cost of a potential shared governance with the likes of the EFF in the future which will only accelerate the inevitable crash.

Personally, I don’t really believe in luck. I just believe the world is so dynamic and vast that we’re incapable of taking all factors into consideration. We have a phrase for negative things that happen because we simply didn’t know….it’s called bad luck. It’s not a coincidence that people who make smart decisions in life get ahead. Some people call them lucky. I think they just made smart decisions that influenced their future.

Where the world and markets are going, who knows. I believe we’ve arrived at a point never before reached in history. The gene coefficient is consequential from the worlds movement towards the forth industrial revolution. Who knows how the world will deal with the expanding group of people who are becoming more irrelevant in the modern world (at least from a contribution perspective).

I’ll be bold and say there’s a 51-100% chance the slide into collapse for SA continues at the current trend of policy of the ANC.

If the ANC, their looting and policies don’t change, why would the slide into the economic black hole stop?

In some instances, science can be applied, in the form of the laws of nature to shine a faint light on what is possibly going to transpire in the future.

There is no science in predicting the future when it comes to politics or economics, because there are too many unknown unknowns (to use Donald Rumsfeld’s famous phrasing). Nobody knows what chance events or black swans could be out there. No matter what you think is obvious, your best guess is still only that – a guess.

@Patrick Cairns

Cause all political and economical models are hot air? Because no set of mathematical equations are used and history is completely disregarded.

Guess that is why so many people repeat history, because they chose not to take any wisdom or lessons from the past and thus history repeats itself.

Why don’t you write an article how everyone, including financial advisers should just flip a coin for all future investment decisions since markets can only really go up or down, I mean 50% chance you’re right and 50% chance you’re wrong, right?
Cause let’s at least agree on one thing, markets won’t stay stagnant for the rest of time as we know it.

Just because we (as a human race even with the help of AI) aren’t yet able to predict black swan events doesn’t mean we should just flip a coin for every and all decisions.

Patrick, Thanks read Daniel Kahneman Thinking Fast and Slow (also a good read is Michael Lewis The Undoing Project, the story behind Kahneman and his friend Tversky) and have just finished the Black Swan. Brilliant, once you are aware of these things it is easier to spot.

By the way @ Doc63, comparisons to games or gambling is known as the ludic fallacy.

One often found awareness of biases certainly helps one in spotting them but not being affected by them.

Best thing to rely on is personal instinct, especially if you’re taking the risk for the decisions to be made. Information helps shape your instinctive reaction. But it’s usually your initial gut instinct that is correct. In my opinion.

In my experience, if it doesn’t go up or down, it will be flat.

Does Kahneman not then contradict himself by explaining how valuable an expert opinion actually is? He is then an expert in behavioural science. I’d need to read his book to make further judgements but believing that most/many situations play out because of luck or chance is a bit… unimpressive? Personally, the search for finding meaning in different situations and the past is one way we find value in life.

Kahneman doesn’t have a problem with experts. We must have experts to provide guidance – to explain what we are seeing around us. What he cautions against is anyone treating the predictions of those experts as more valuable than they actually are. This includes the experts themselves. He gives an excellent example of how he proved that predictions he himself was making about the leadership qualities of soldiers in the Israeli army were just about useless.

You say it’s unimpressive to put most things down to change or luck, but consider that just before the sperm fertilised the egg that turned into Adolf Hitler, there was a 50% chance that the little Hitler baby would be female. It is a matter of chance that the Hitler baby was male. How different might the 20th century have looked if chance had gone the other way?

As humans we don’t like to believe that chance plays an oversized role in everything. We want to believe everything works on cause and effect. But the truth is that the very reason that the future is unknowable is precisely because there is so much chance involved in everything.

Totally agree, Patrick.

Life – and EVERYTHING in it – is a gamble. From the get-go.

The only thing certain about “certainty” is that it is uncertain.

@Patrick Cairns

Yeah just disregard something like causality, cause when you throw a pebble in a pond it’s just chance that it makes ripples on the surface and the pebble sinks. 50% chance it doesn’t make ripples and 50% chance the pebble floats.

Causality (also referred to as causation, or cause and effect) is efficacy, by which one process or state, a cause, contributes to the production of another process or state, an effect, where the cause is partly responsible for the effect, and the effect is partly dependent on the cause. In general, a process has many causes, which are also said to be causal factors for it, and all lie in its past. An effect can in turn be a cause of, or causal factor for, many other effects, which all lie in its future. Some writers have held that causality is metaphysically prior to notions of time and space.

The same way something like Newton’s laws of motion are just based on chance which means any scientific prediction that is calculated from these laws and their outcome is just based on chance and not on what was observed and calculated in the past.

While the idea that the future can’t be predicted is drawn from Chaos Theory and Dynamical Systems, there is a feature of some Chaotic Systems that one is interested in: that is Spontaneous Order.
The model first proposed by Yoshiki Kuramoto gives one a sense of what it is about: oscillators each have their own frequency and each is coupled equally to all other oscillators. This fully non linear model can be solved exactly, which is against the grain of most dynamical models.
But, in lending terminology from the field, my question would be: if South Africa is a chaotic system, what are the oscillators (prime drivers), what are our natural frequencies? and if we as the oscillating groups are all coupled then at what point do we come into synchronisation?
The constitutional order was meant to lead to that synchronisation of groups. Obviously some of the oscillators weren’t vibrating at their natural energy, and the system has long been breaking down. What kind of conditions are necessary in South Africa for spontaneous order?
This is the gist of my 1000 year question.
To quote James Flecker who also contemplated the 1000 year question:
“I care not if you bridge the seas,
Or ride secure in the cruel sky,
Or build consummate palaces
Of metal or of masonry.
But have you wine and music still,
And statues and a bright-eyed love,
And foolish thoughts of good and ill,
And prayers to them who sit above?

And of course we have the perfect example of Naspers and their purchase of 46.5% TenCent for $32 million now worth about $175 billion. Koos Bekker is the first to admit it was like throwing mud at the wall and seeing what sticks.

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