I say this because knowing the every gyration of the market and economy can create the illusion that one is brilliantly well informed. The reality is that the more you find out about investing, the more you realise that there are such an enormous number of variables that it’s impossible to understand them all – markets are a collection of people after all, and although people are predictable to a point, they become inherently unpredictable once normal market conditions break down.
This reflects the idea of the market as a complex and constantly evolving system, and if we take into account that markets do not operate in splendid financial isolation, but within a huge world system of resource competition, political hierarchies, and social interactions you get an idea of how the complexity involved in investing increases further still. As Ian Smith superbly explains in his Taking Stock column on page 49, a key problem in investing is to oversimplify these relationships and so misunderstand cause and effect. Even if investors are taking a long view, as they should be, this introduces the risk that what are identified as trends and correlations prove to be nothing of the sort. In other words, a decision you take for one reason could have very different results than you expect.
The idea of complexity theory is now, thankfully, making its way into the thinking of policymakers and regulators, who recognise that although useful the simple lessons of the past are poor analogues for a multi-layered global financial system that involves more inter-dependency than ever. But there remains a dangerous linearity in much economic thinking. This can be forgiven, as academics are still a very long way from mastering their knowledge of how such complex systems behave, and that means making accurate predictions remains as much an exercise in crystal ball gazing as ever. As the economist JK Galbraith once put it: “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” The recent flurry of failed political and market predictions and the confused reaction to Trump’s victory are a very useful reminder of how right he was.
