Matt Franz : Zealous For Knowledge

The Futility Of Forecasts

“Trading A Little Dull, With Prices A Little Lower”

This was the headline in the New York Times on June 30, 1914. The story read:

The assassination of the heir to the Austrian throne was an event whose consequences were closely considered by the markets abroad, but the calmness which they showed indicated clearly that political complications were not feared as a result of the incident. Indeed, the view that it would tend to lessen rather than to increase political strife in southeastern Europe found wide acceptance.

We all know that the assassination of Archduke Franz Ferdinand set off World War I. But it was not at all clear at the time. It only makes sense with the benefit of hindsight.

With hindsight we can look back at the past and make sense of everything. Our brains crave understanding, so we find patterns even where none exist. We ascribe events to a cause-and-effect framework, even though they were random or the effect was unpredictable at the time of the cause. This makes us over-confident about our ability to forecast the future.

Another example comes from Kitty Hawk. The Wright brothers completed the first heavier-than-air flight on December 17, 1903. In hindsight this was a momentous day that would change the world forever. But the next morning there was no mention of their exploits in the New York Times. The Times wouldn’t even make a passing comment about the Wright brothers until 1906, three years after they invented the airplane.

After the first flight at Kitty Hawk the Wright brothers continued refining their airplane in Dayton, Ohio. They flew it around town in clear sight of everyone. Here’s what historian Frederick Lewis Allen wrote about that time:

Several years went by before the public grasped what the Wrights were doing; people were so convinced that flying was impossible that most of those who saw them flying about Dayton in 1905 decided that what they had seen must be some trick without significance – somewhat as most people today would regard a demonstration of, say, telepathy. It was not until May, 1908 – nearly four and a half years after the Wright’s first flight – that experienced reporters were sent to observe what they were doing, experienced editors gave full credence to these reporters’ excited dispatches, and the world at last woke up to the fact that human flight had been successfully accomplished. (Source)

If we cannot depend on an accurate forecast of the future, what can we depend on then in our investments?

A wide margin of safety. Ben Graham taught that the purpose of a margin of safety was to render the an accurate forecast of the future unnecessary. Most investors focus on forecasting the future, even though all of the evidence suggests that no one, even experts, can reliably do this. Albert Einstein said, “The definition of insanity is doing the same thing over and over again, but expecting different results”. In the next post I will discuss the concept of a margin of safety in more detail.

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