The master of risk, the great Howard Marks of “Memos from the chairman” and Oaktree Capital stardom, not to mention his must read book “The Most Important Thing”, once clarified: “I didn’t write a book about investing methods, or tried to convey an easy way of investing. I deliberately wrote a book about mindsets and psychology”
He went on to explain how investing isn’t easy at all, quite the opposite.
As Marks says, reasoning about financial markets and investments has a way of turning back on itself. Valuation, momentum, popularity, money on the sidelines, volume, trend uniformity etc. all have a recursive element to them: If I know this, maybe everybody does. If this is cheap or the trend is negative perhaps it’s for a reason. Money on the sidelines might be because of poor prospects for risk assets, or does it mean latent buying power? Is popularity good or bad for a stock…
“It’s complicated” is a catchphrase for most mature relationships. Well, “it’s complex” is its financial equivalent. “Complicated” means something contains a lot of details, like an expensive mechanical Swiss watch. Complex means a system of moving, interdependent parts in hard to define relationships to each other. Newton’s 3-body problem isn’t very complicated but it’s so complex there is no solution.
The market is a complex soup of math, statistics, psychology, politics, randomness and game theory, to mention but a few ingredients. There is no final solution, no final model to follow, no forecasts worthy the name.
So what can you do faced with the complexity of financial markets?
You can be agile
You can be curious. You can be a learning machine. You can engage with and understand your adversaries, never being content you know enough, never resting on your laurels. You can explore several different ways of calculating the same thing. You can use several different valuations methods, and several different multiples within each method. You can map owners, directors, suppliers, competitors from several different aspects. You can investigate absolutes as well as relative valuation, momentum, competitive positioning, political risk, customer satisfaction, possible substitutes, technological development etc.
Don’t believe everything you think
There really is no end to the work you can put in. And yet, there is no definitive answer. You can still be wrong, since investing in (risky) assets means there are several potential futures but you will only find yourself in one of them. If it’s a less likely one, one you didn’t want, you’ll have to be agile enough to adapt your calculations and decisions according to the new circumstances.
Valuation and investing is about a never-ending dynamic triangulation
fundamentals, trends and other people’s sentiment and knowledge
Actively seek new and seemingly impossible angles regarding all three
Be aware of vantage points different from your own
In my book about 15 years at the best performing hedge fund in Europe over a decade, I list 50 rules of investing.
This post is one in a line of articles detailing and explaining some of my most important insights from that time. Taken together I believe they will make for a useful and inspirational reminder for evolving and consistently improving your investment habits. Whenever having a bad experience in the markets, or exhibiting signs of hubris after a lucky streak, refer back to these twelve ideas, thus combining your own experience with mine to maximize your investment wisdom.
Agility means seeing market complexity for what it is
- Macro forecasts are mostly useless (whatever forecasts are possible are useless anyway since they tend to get discounted)
- You can never be certain (see forecasts), but you can line up probabilities in your favor
- There is no one definitive answer, but you can keep several potential candidates in mind
- Recursivity, interdependence, group psychology and randomness mean no situation is the same; a fact made all too clear to me in the most recent long bull market
- I erreneously thought all the facts I needed for a re-run of some of the worst downturns in history were in place. Had this been my first bull, maybe I would have been less complacent and more open to the merits of, e.g., concerted money-printing not to mention the resolve (madness) of central bankers
- Agility means being open to alternative explanations and scenarios, without succumbing to the 50/50 fallacy of two scenarios always being equally probable
Equity research and (value) investing
is as complex and frustrating
Escher’s art and impossible figures
Agility is the seventh article in my 12-part series of TAOS – The Art Of Sprezzatura. You can buy the artwork here. If you missed the previous six articles you can find them here: Strategy, Patience, Resilience, Endurance, Zeal and Zen. Five more are coming over the course of the next five weekdays.
Occasionally I will offer subscriber-only material in my newsletter. Please sign up (it’s free, and it includes my book about hedge fund investing), if you want to make sure you don’t miss out on freebies, offers and subscriber-only discounts on special products.