When You're Rich They Think You Really Know

With very little legitimate information, we often rely on the strangest of guides

Summary:

• George Soros’ principle of fallibility, states that participants' views of the world are always partial and distorted, and these distorted views can lead to inappropriate actions that change the situation. This reflexivity means rising stock prices can influence underlying values, creating a self-referential loop where outcomes impact fundamentals.

• Financial assets are inherently unpredictable, but the bubble-like nature of the current environment is undeniable with simultaneous dynamics of rising bankruptcies and deteriorating corporate profits while markets price low volatility despite worsening fundamentals.

Top Comment:

Doug Blaheta: “Mike Howell seems to believe we have hit the bottom and the stealth liquidity injections by CBs will prevent a credit event and/or a downturn in equities and rates will trade sideways for quite some time. I do not have the expertise to discern which thesis seems more plausible.”

MWG: Doug, this one’s for you!

The Main Event:

We often forget how little information we have on the behavior of financial assets and the implications of their behavior on real-world outcomes. George Soros is well known for his theories of fallibility and reflexivity which comment on both:

I can state the core idea in two relatively simple propositions. One is that in situations that have thinking participants, the participants’ view of the world is always partial and distorted. That is the principle of fallibility. The other is that these distorted views can influence the situation to which they relate because false views lead to inappropriate actions. — Soros, Financial Times 2009

The first insight, that under any conditions, I can have, at best, an imperfect view of the world, is a critical one. I cannot KNOW anything, especially about the forward path of something as derivative as common stock prices which rely not only on an unknowable distribution of collective beliefs about forward cash flows, but also interest rate policy, tax policy, social policy, market microstructure, etc. I CAN construct a hypothesis (forecast) as to the individual components, but the error in the combined forecast suggests this is a largely futile exercise designed to merely provide me with some comfort that my predetermined actions are following a “process.”