Weekly Message: Uncertainty and Illusions

Every now and again someone will ask me what I think about
so and so market guru’s prediction that stocks are either going to the moon
or sliding into the gutter. As I’ve reported the past couple of weeks, some
legit personalities have been in the market-sliding-into-the-gutter camp. The
beauty of the equity market lies in its unpredictability: It is the quintessential
humbler of mortals whose egos convince them that their past investment
successes indicate that they’ve some unique and/or uncanny predictive prowess.

…in early 1995, Jeffrey Vinik, the manager of Fidelity
Magellan, then the world’s largest mutual fund, got trampled by the markets as
the internet technology boom was about to take off. At the time, Vinik held
over 40% of the fund’s assets in technology stocks, proclaiming that most of
his investors “have invested in the fund for goals that are years away… I
think their objectives are the same as mine, and that they believe, as I do,
that a long-term approach is best.” But only six months after he wrote
this, Vinik dumped almost all of his technology shares, selling close to $ 19
billion worth in two frantic months. In retrospect, it’s clear that Vinik
was right on the money with his large allocation to technology companies, but
fearing that the already “overvalued” tech stocks were due for a large
correction, he deprived his investors of the windfall from one of the most
spectacular bull markets ever. At the other end of that same bull market,
another star manager made a similar and equally unfortunate mistake. While
working for George Soros in 1999, Stanley Druckenmiller accumulated a
significant short position in internet stocks he believed to be stupidly
overvalued. He was right, of course, but the Nasdaq’s meteoric rise eventually
made him blink, cover his shorts and join the bulls on the long side. Shortly
thereafter, the dot-com bubble burst and 75% of the internet stocks
Druckenmiller shorted eventually went to zero. The rest of them fell between
90% and 99%. Instead of making an absolute killing in 2000, Stanley
Druckenmiller ended up with the biggest loss in his career.

All too often, spurious patterns and superstitious thinking
accidentally produce the right results and then get dressed up as good
investment advice. Smart investors need to hone their critical faculties to
detect these fake tools, in just the same way they need to be wary of people
who claim to have a perfect investing strategy.  

And helps us understand how the stress of market uncertainty
— and the human need to control — can trigger illusory thinking that acted upon would in all likelihood do great harm to our bottom lines:

Uncertain conditions are those that are most likely to cause
us to generate the random connections between events that, to all intents and
purposes, look like superstitions. The key to these superstitions is that they
allow us to try and exert control over the uncontrollable: they turn the
unknown unknowns we can’t control into knowns that we can. As investors, this
means we start thinking we can predict the future, when the truth is we haven’t
got a clue. What do you think happens when an investor starts making investment
decisions on the basis of illusory patterns? Yep, they tend to lose a ton of

So, please, never ever, evereverever,
get fooled into believing that the blokes who I featured in my August 4th
and August 9th videos (below) can know what they would have us believe
they know.

Now, those featured guessers just happen to be among the ones who have the market
heading to the gutter. We must also apply the very same skepticism to those mavens
who have it heading to the moon.

Have a great weekend!


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