Updated: Dec 30, 2020
What is going on here? We ask ourselves, without knowing how to respond, since the beginning of the emergency. Often, in anguish, we have not gone beyond abused concepts when an unknown danger breaks into our lives and the economy: the "black swan" or the "unknown unknowns" of the former Secretary of State Donald Rumsfeld.
Rather, it would be better to give up our (tenacious) ambition to control reality by abandoning the application of probabilistic scenarios to the economy: the economy is intrinsically brought to reflexivity (that is, to influence itself) and, therefore, escapes the probabilistic measurement as radical uncertainties persist.
As Mervyin King, a London School of Economics academic and former Governor of the Bank of England, points out, economics is not an exact science. If you send a satellite into orbit around Mercury, you can know with absolute certainty where once launched, six years later, the satellite will enter the orbit of the planet. The economy does not work like this: there are only patterns, orientations, historical trends.
At the moment we are living, concepts such as radical uncertainty, to which two British academics have dedicated an essay, John Kay (Oxford University) and the aforementioned Mervyn King, are more appropriate; or the inability to know the future of Howard Marks, co-founder of Oaktree Capital Management.
Today there is much discussion about what form the recovery of economic growth will have (whether V, U, L or square root) but to establish it we should be able to compare the events of these months with similar situations of the past. Unfortunately, they are not there. It is impossible to say with certainty what will happen without being able to count on a precedent. Therefore, it is better to modify one's mental equipment.
The events of this period draw a historical unicum made up of four phenomena (pandemic, contraction of the economy, falling oil prices, adoption of new monetary policies) which renders forecasts and surveys unreliable. Not only are the four phenomena difficult to analyze by themselves, but it is not known how they do interact.
The comparisons with the crisis of 1929 do not hold up although, this time, the policies adopted seem more appropriate and try to capitalize on the errors of 29. Starting, at least in the United States, with the choice to fully bring out unemployment and concentrate the efforts on the monetary component. Although with some undesirable effects (for example, the dilution of the monetary base, moral hazard or, over time, inflation difficult to control), the application of Modern Monetary Theory should lay the foundations for reabsorbing unemployment once the economy. The optimistic scenario include that unemployment will be reabsorbed by the best companies in a sort of Darwinian selection.
On top of that, there are also questions for the short term: will monetary policies be enough to repair Covid-19's damage? Will the reopening of the economy bring about a new wave of contagions and a return of lockdowns?
The answers are conditioned by a very large number of variables: combining them with the four phenomena mentioned makes the definition of estimates for the future an unsolvable equation. The magnitude of the variances recorded by the variables involved suggests not to venture into the forecasts based on what happened in the past to interpret the situation as a whole. After all, while expanding economies are alike, those in crisis are each a separate case, a bit like Anna Karenina's principle ("All happy families look alike; every unhappy family is instead unfortunate in its own way").
At a macroeconomic level, forecasts are a little easier although of limited utility because the data is known by everyone and therefore probably already incorporated into the price of the assets. These data are useful only if you aim to follow an investment trend.
Fight (your own) prejudices can be a bargain
Relying on forecasts (an exercise that is often useless in itself) even runs the risk misguide you in a time of epochal changes, also because the weight of prejudices (biases) has to be taken into account.
The path that leads each of us to get an idea of the future is strongly influenced by reflexivity (that is: self-influence), personal expectations, character, political opinions. Which leads to the creation of armies of optimists and pessimists particularly fierce as it has been found in the media debates of these weeks.
Opinions and personal expectations, practically impossible to eliminate, limit objectivity and must, therefore, be taken into serious consideration. These cognitive biases (confirmation bias) weigh particularly when economic analyzes cross the feelings connected with the Covid-19 pandemic (suffering, fear).
Can we fight our prejudices? Something can be done, for example by selecting information sources other than those that reflect our political ideas and therefore increasing the ability to read reality. Above all, when we talk about investments, we can (and must) leave the field open to new possible visions.
In the Simplify 02 investment committees, we give ample space to doubt, to what we do not know and about which we must gather information or investigate, and update our analysis models.
Investment ideas also originate from this opening. An example? The recent decision to invest in oil tankers assuming an increase in freight rates resulting from the combined effect between the collapse of crude oil prices and oil overproduction. We recalled, from the global financial crisis of 2008, that certain conditions of the crude market lay the foundations for a surge in the freight rate for oil tankers. As this is not a matter of our specialization, we put together the skills of numerous analysts before making the investment.
Awareness of not knowing and doubt are, therefore, a good operational premise, but experience (twenty five years in the case of our team) and the possibility of using professionals who cover all the economic areas to be involved from time to time according to need.
Simplify 02 operates on the basis of two principles: long-term investment approach and team participation in the result (even negative, in the form of a loss of future professional opportunities in the event of failure).
An approach that seems particularly advisable in today's scenario. There are few cases in which we know less than when a new virus appears: the things we ignore prevail over the known ones and on which it is possible to make predictions. The faster you accept this fact, the more you are in a position to preserve capital pending the right wave.
A humble approach, based on the awareness that our knowledge is limited, and the control of cognitive biases is the best virtue to face the new game.