Superforecasting and A Few Unpleasant Truths

Came upon these two interesting posts about super-forecasting and the stock market, which I have lumped together because they pretty much cover the same subject matter.

Superforecasting for Dummies

Reality-Plus A Few Unpleasant Truths (That Can Make You a Lot of Money)

From the Reality-Plus:

Here’s the dirty little secret that most wealth management companies don’t want you to know: it’s actually not that hard for an average retail investor to predict the market. There are a handful of key indicators that correlate pretty directly to whether a stock will do well or not. The issue is that nobody seems to understand what these key indicators are, so instead economists treat everything as if it were significant. The problem with economics is basically the same problem that plagues every scientific field: we are drowning in data and cannot distinguish signal from noise. In the past, data was scarce. This meant that in the past, being a good scientist involved gathering and correlating as much data as possible. The more information you factored into your analysis, the more likely it was to be correct. Today, we live in the opposite type of world. It is easy to gather information on just about anything you want: it’s just that 90% of that information is either useless, or total bullshit. That means in the modern world, the hallmark of a good scientist is distinguishing signal from noise, knowing which pieces of data are relevant and which are irrelevant and need to be disregarde

I agree…predicting this stuff is easy. Anything involving fiance, econ, investing is super-easy. Predicting political events is harder though. Whereas capital seeks to optimize its returns relative to risk among all alternatives (the so-called gradient theory of asset allocation), voters are swayed by many factors. Similar to the author above, I was able to realize a significant return in the market using 3x ETFs (whereas he used a REIT). The 3x tech ETFs have delivered superior returns, up 500% from the lows of Covid and since 2010 has posted 50-100% annual returns.

Agree..most information is unless (such as the hype-driven, always-wrong financial media). Knowing what investments and news to disregard can put you way ahead of the pack. A simple, ‘tried and true’ strategy is to always stay invested in the market and only selling when you need the money, instead of selling into panic or fear. Given that the market almost always go up more often than not, trying to time it usually results in selling at close to the bottom and buying back in at a higher price.

The ‘scam’ is how the financial media, money managers, and the overrated experts perpetuate this lie or myth that this stuff cannot be predicted, either out of ignorance (because they cannot do it) or motivated by profits (it’s easier to sell someone a solution if you can convince them the problem is hard). Fund managers and wealth managers charge high commissions to justify their expertise, when anyone can achieve far better returns on their own and not have to pay any middleman. I have seen firms that charge a high commission for what is effectively a Vanguard fund. It’s a form of arbitrage: charge clients 1-2% for a fund that costs .1%, pocket the difference.

An interesting finding from Superforecasting, by Philip Tetlock and Dan Gardner, is that great intellect is not needed to be a super-forecaster. If anything, it is a hindrance, because smart people are always coming up with complicated rationalizations for things, when the reality or the answer can be less circuitous. A simple set of heuristics, an example being that if given a choice between having to predict between a better outcome or a worse outcome for some event– be it China, climate change, civil unrest, the US economy, etc.– history favors optimism, can give laypeople a significant edge over the experts. Knowing the ‘gradient rule’ of capital is another.

The appeal of incorrect narratives is that they are more exciting and fills the human desire to see retribution to those who ‘wronged’ us. The scenario in which society suddenly falls apart and elites get their comeuppance, is more exciting than the much more probable outcome in which things just muddy along for many decades and elites simply become bigger, richer, and more powerful. What makes for a riveting movie or story does not usually suffice as a useful framework for understanding reality and making forecasts.

Regarding GameStop (GME) he writes:

The final outcome of the GameStop short squeeze was totally predictable to anybody who understands how oligarchies work. Another more obvious example of how the oligarchy monopolizes capital can be found during the subprime mortgage crisis of 2008, when giant banks were considered “too big to fail” and received massive bailouts to cushion them from their risky behaviors, while many average citizens – whom the bailout was allegedly designed to protect – lost their houses and fell into poverty.

Not necessarily. If it were so easy , the author or anyone else could have bought put options on GameStop betting on this outcome (I didn’t). AFIK few, if any, people actually did. Robinhood temporarily stopping the purchase of GME was truly an unprecedented situation (in over a decade of trading I have never seen anything like that). Although penny stocks are occasionally halted by the SEC, a broker suddenly stopping buy orders on a large stock that is otherwise in good standing with the SEC and in the absence of any regulation, is uncharted territory. Hedge funds fail all the time (as we saw in 2007-2009), so it’s not like like there was any reason to believe that Melvin would be spared a similar fate.

Individual stock picking is hard and instead I focus on a couple dozen or so large companies and ETFs that meet certain criteria (focusing on large, multi-decade themes rather than short-term fads and trends). Such criteria narrows the pool of suitable investments from thousands to just maybe 20 or so. This delivers superior returns but with considerably less risk (specifically, idiosyncratic risk [1]) and volatility. If you know within half a century or so, as few as a dozen companies will provide the entire digital and even physical infrastructure to America and the world, it logically follow that such companies will probably be good investments. That is what is happening with Walmart (offline) and Amazon (offline and online). Microsoft is a digital infrastructure play, analogous to PG&E a century ago. Tesla is a transportation and physical infrastructure play, like Union Pacific a century ago.

[1] The idea is, if you are highly confident you know the overall market (such as the S&P 500) will be up a month, a year, a decade, from now, you generally want to seek investments that will realize this upside. So the problem with individual stock picking, especially small and medium-sized companies, is that it introduces firm-level risk , which is much harder to predict compared to easy-to-understand and predict macro factors.

1 comment

  1. So many intelligent people get caught up in nuance instead of doing what is pragmatic. I don’t know if it’s their own personal belief that some complex technical analysis can be used to make profit or if they’re just hired to do so and don’t have a huge stake in the outcome. I would bet on the latter because many managers believe intelligence is like magic and if you hire someone smart enough they’re basically interchangeable with an oracle. Essentially, once you hit a certain threshold you can see the future. You can read people’s thoughts and you’ve got all the answers. A big income with all the benefits is justified because those employees will pay back in dividends. Meanwhile, all he has to do is use some six syllable words, cite some obscure theory, and create some complex looking data that flies over everyone else’s head. The manager will think he’s got himself a moneymaker.

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