By Jonathan Bernstein, Stringer Asset Management
There is an old Danish proverb that roughly translates to “It is difficult to make predictions, especially about the future.” History has consistently proven that to be the case. The coronavirus is just another example of this as it has upended every aspect of life across the globe. It goes without saying that this pandemic has been more devasting in terms of lives lost, economic impact and the toll it has had on people’s mental health than anyone could have imagined. If it were a movie, it would fall squarely in the science fiction category. Regardless, we find ourselves shuttered in our houses and social distancing while trying to be productive working from home if we are lucky enough to be employed. The impact of the coronavirus has been sudden and devasting. Predicting an end is a futile effort as there is no silver bullet yet and until there is a vaccine, there is a high probability that the current saga will continue. It has been a challenge to navigate the financial markets and the behavioral toll it has taken on investors. We are constantly asked about our prediction on when this will end and how that lines up with our outlook and positioning. While that sounds difficult if not impossible, with right framework and asking the right questions, we can start to build out what that might look like and begin to make some decisions. Innovation typically starts with a problem often thought insurmountable. We can find examples of how processes help guide us to answers to even the most daunting problems throughout history. In the following, we will outline how we utilize critical thinking, a framework, and a process for navigating markets that can also apply to almost any situation.
First, in today’s environment of information overload, it is very easy to get caught up in partisan opinion and media bias regardless of which side of the aisle you might sit. Before even looking at the framework for answering the questions above, a commitment must be made to critical thinking. Critical thinking at its core is the objective analysis and evaluation of an issue in order to form a judgment. Objectivity is the key and refers to the elimination of subjective perspectives (e.g. emotions and feelings) for a process that is purely based on hard facts. As Senator Daniel Patrick Moynihan once stated, “Everyone is entitled to their own opinions, but they are not entitled to their own facts.” We all have biases but it’s important to acknowledge them, do our best to eliminate the behavioral biases, and focus on the facts so that we can begin to gather hard data and apply it.
Secondly, flexibility and a willingness to reevaluate and change our inputs when the circumstances evolve is crucial. We do not live in closed environment and, as the recent events have reminded us, everything can change in a heartbeat. To be successful in forecasting and in life for that matter, we must be willing to adapt to new circumstances and information. Paul Samuelson, who was awarded the Nobel Memorial Prize in Economic Sciences, once stated in an interview “Well, when events change, I change my mind. What do you do?”
Finally, once we have done all we can in terms of objective research, gained a diversity of opinion, and acknowledged the behavioral biases, we can apply it to our process. The process we use is called Multiple Scenario Analysis (MSA), which is also applied by the CIA, the oil and gas industry, in medicine, and many other endeavors where critical projections and decision are necessary. One of the greatest strengths of MSA is that it can be used as a framework across many different fields. In our case, we employ it to look at economies, markets, and investments. To summarize, MSA involves viewing an opportunity in terms of best, base, and worst-case scenarios. Then, we develop the factors that contribute to those various outcomes. Finally, we assign probabilities to those possible factors, which ultimately creates the probabilities for the best, base, and worst-case scenario. Over time, with things set in motion, these probabilities shift as those possible factors play out. The best, base, and worst-case scenarios begin to emerge. From an investment perspective, this approach forces an investment team to recognize their behavioral biases and to consider the identifiable factors that will alter the path and destination of a forecast. MSA does not try to show one exact picture of the future, but rather it consciously presents several alternative future outcomes. This can help us recognize mistakes earlier and help ensure continuous validation or invalidation of our thesis. More specifically, it can help to eliminate several of the typical investment mistakes related to behavioral flaws and the human condition.
In today’s chaotic environment, we think it is extremely important to apply MSA, which allows us to change our inputs and change the probabilities. We see this happening outside of the investment world every day in drug trials, infection and recovery rates, and mortality. Within the investment world, we see changes in layoffs, commodity prices, GDP projections, and shifting probabilities, among thousands of other inputs. The more we learn, the more clarity we can develop around potential outcomes. The future is always uncertain and unknowable. However, with critical thinking, flexibility, and a great process as the foundation, we can put the odds in our favor and hopefully create better forecasts.