November 4, 2024
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Investing is a massive field, and it connects to many other areas, such as economics, government, politics, international trade, foreign conflicts, currencies, and people’s behavior.
Investors often seek help from professionals to answer their questions about the market. However, just like a doctor cannot answer all health concerns, investment professionals cannot provide all the answers about the market. They need to be honest about what they know and be ready to adapt. It’s important to ask, “And then what?” when you think you understand a situation in economics and investing.
In one of our recent articles, 100 Years of Wisdom, I discussed one of the most valuable lessons I learned: actively acquiring knowledge. Charlie Munger would say we are to “learn the method of learning” and “wisdom acquisition is a moral duty.”
Often, I purposely acquire understanding outside of the investing landscape. I recently read an interesting article from Scientific America in January of 2024. There has been an invasive ant species called “the big-headed ant” in Kenya, Africa. It’s incredible how a small ant is affecting the entire ecosystem.
How an Ant Population Can Completely Change its Ecosystem
Native acacia ants are fierce defenders of the acacia trees in which they live. When animals would come to eat the acacia leaves, these ants swarm and attack the animal. For elephants specifically, these ants would crawl up the nose and pinch the elephant from the inside. It’s a great example of a symbiotic relationship.
Recently, an invasive ant species has been introduced to the region. The invasive ant species is called the “big-headed ants.” The big-headed ants – although smaller – are killing off the acacia ants. They come in greater numbers and team up against the acacia ants. These big-headed ants attack a limb at a time and dismember the acacia ants. (See picture) It’s just a small ecosystem change no one will notice… right?
And then what… Well, this small invasion of big-headed ants started to overrun the acacia ants, and the herbivores soon figured this out. The acacia trees were now left defenseless. Elephants do the most damage and no longer fear damaging or eating the acacia trees. So now, the acacia tree coverings and their population are declining.
And then what… With less tree cover, the zebras are now safer. How could this be? Well, acacia trees were often used by lions as cover for hunting. Lions have lost a strategic part of their hunting tactics, making it harder to hunt zebras. Zebra kills are 2.87 times higher in uninvaded areas compared to areas with big-headed ants(1). Now, the zebra population is steadily increasing.
And then what… Lions still need to eat, right? To compensate for the loss of zebra in their diet, they started hunting buffalo more often. Buffalos are more dangerous to hunt. Buffalos are larger and more aggressive in defending themselves than zebras. The lion population so far has not suffered, but their hunting experience is now more difficult. The lions are successful enough that the buffalo population has started to decline.
I’m not sure who would have predicted the big-headed ant being introduced in Kenya would have resulted in all this change, but I certainly would not have. It’s a great reminder of how ecosystems are connected. Something so small can have a big effect, such as a positive for some, a negative for others, and indifference for the rest. We can rarely predict the magnitude of such changes, and that is if we are aware a small change occurred in the first place. Some may have thought this ant could have brought amazing success in the area, others preach doom and gloom, while the rest believe nothing will change.
Can We Know the Big Questions?
How does this relate to investing? No matter what expertise someone has or how much modeling has been done, it’s impossible to predict what happens in an extremely complex system operated by complex beings.
It’s natural for people to ask why things are happening: Why is the market up (or down), what is going to happen after the election, what do you think about XYZ company, will the Fed raise (lower) rates, what company should we buy to profit from… (AI, cannabis, cloud storage, or any other hot topic), etc. These are all legitimate questions people may have, and I believe it’s better to ask your financial advisor these questions than your crazy relative who can’t wait to give their opinion.
In macro(big) economics, no one knows what will happen. I will never answer with certainty when it comes to macroeconomic questions. Even the most professional investors will only be able to gather a fraction of the information necessary to predict macroeconomics.
My favorite economist, Thomas Sowell, once said, “It takes considerable knowledge just to realize the extent of your own ignorance.”
Understanding the Movement of Stock Prices
The price of stocks – because they are priced daily – can go up and down in what may seem like a random walk. Some may try to come up with a system of historical patterns to predict future price movements. Financial advisors seek to provide confident answers to clients’ questions, like “Why is the market behaving this way?”
When someone asks a professional, “Why is the market …” too often, the answer is from the echo chamber given by all financial “experts” and news outlets. Most financial professionals don’t come up with their answers but repeat what they have heard. I may have some ideas, and Steve and I are willing to share ideas. However, we rarely have enough information to act on our opinions.
It can feel rewarding to answer clients’ questions confidently. Just as doctors prefer not to respond with, “I’m not sure what’s happening” to their patients, financial advisors also aim to convey certainty. Yet, how many times have we received advice from the doctor that later proved to be inaccurate?
Financial professionals are the same in that they always want a good answer, and understandably so. Some want an answer to genuinely help, while others enjoy the ego of giving answers. I believe financial professionals – possibly all professionals – need to be very careful when giving answers and be honest if it’s only their opinion or if they lack the information to have the full answer.
A quote Steve and I have said from Benjamin Graham, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” A voting machine is the sentiment of people at a given time. The “market” is a group of people having uniquely complex situations: emotional mindsets, fears, greed, emergencies, wars, and expectations. People, as individuals and as a group, can make unbelievably crazy decisions. This is how stock prices move over the short term.
A weighing machine can measure something of substance. What is measurable is the cash flow and returns a business generates or the assets the company owns. Over the long term, the prices of a stock will match very closely with the return of cash generated from the business.
The Fallacy of “Knowing” What is going on
For over the past decade, many financial professionals have claimed that the stock market was overvalued. Some have expressed a pessimistic outlook, citing government money printing and the potential for hyperinflation following the Great Recession as their main concerns. While we did experience some significant inflation in recent years due to the pandemic, it did not escalate to the level of hyperinflation. Before the pandemic, we experienced very little inflation for 10+ years.
Others gave reasons why the stock market’s high valuation was acceptable, such as interest rates were very low and the Federal Reserve was executing quantitative easing. Now, the stock market is still “high,” but interest rates are much higher, and the Fed is now tightening (the opposite of quantitative easing). Both prevailing but opposing crowds had different reasons and explanations, yet both were wrong.
Most people don’t have evidence to explain why things are the way they are. If investment professionals were honest, they would admit almost all their economic predictions have been incorrect. More than likely, we don’t have an answer, and we don’t need to make one up.
“A great philosopher said, ‘A man never steps into the same river twice, the man is different and so is the river when he goes in the second time.’ That’s the trouble with economics. It’s not like physics. The same damn recipe done a different time gets a different result.” – Charlie Munger
“Those who have knowledge don’t predict. Those who predict don’t have knowledge.” – Lao Tzu
“There’s nobody’s predictions that we’re interested in, including our own.” – Warren Buffett
“Market forecasters will fill your ear but will never fill your wallet.” – Warren Buffett
“I’d advise you to approach the entire subject of forecasts and forecasters with extreme mistrust.” – Howard Marks
Information We Can Act On
The information Steve and I feel comfortable acting on is understanding company-specific outcomes. Most companies will never be in our circle of competence, but there are enough companies we understand well enough to invest in for our clients. When those companies have an attractive opportunity, we act. This comes when we understand a company’s outlook that the general market hasn’t priced accurately.
What factors do we focus on? If we use Apple as an example, we would focus heavily on consumer behavior. The main revenue source and outlook for Apple (and companies like it) is consumer behavior toward their products: Why they buy it, how they interact after purchase, thoughts on additional purchases, how consumers view its ecosystem versus their competitors, etc. With this information, we can come up with a reasonable understanding of:
1) How many products Apple will sell (Revenue from selling products)
2) How much will Apple make from those products after purchase (Revenue made from product services)
Can we know the answer to these questions exactly? No, but we can come up with an answer accurate enough to make an investment decision.
Stay Away From the Noise
Can I lay out a confident outlook of what interest rates will look like over the next 10 years? No, not even the Federal Reserve can do that. Macroeconomic topics like this receive the most focus from financial news outlets. Steve and I only spend around 5%-10% of our time on these topics. Most of our research and discussion is based on company-specific understanding, like my Apple example.
Evergreen’s advice to clients is to spend most of their thought process understanding their goals and objectives, then communicate that with their advisor about the best way to meet them. We make changes to an individual’s plan if their goals and objectives change. We should avoid the endless “and then what” circle of questions we have to ask about the economy and focus on meeting objectives and applying an appropriate investment approach to do so.
Another great Thomas Sowell quote: “Sometimes it seems as if there are more solutions than problems. On closer scrutiny, it turns out that many of today’s problems are a result of yesterday’s solutions.”
- “Disruption of an Ant-Plant Mutualism Shapes Interactions …”Science, Science.org, 25 Jan. 2024, www.science.org/doi/10.1126/science.adg1464.
Evergreen Wealth Management, LLC is a registered investment adviser. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.