European Capital Partners: The known unknowns
“Prediction is very difficult, especially if it’s about the future”, the Nobel laureate in Physics Nils Bohr is quoted. That was our first thought when we came across a Bloomberg article on the predictions of US equity strategists of the major Wall Street Houses for the 2nd half of the year.
Indeed, over the last ten years, the forecasters have a terrible track record: they only got their prediction approximatively right one time out of 10!
Don’t get me wrong; my intention here is certainly not to do strategists bashing, I just want to make the point that forecasting the direction of the stock markets in the short run is a pure guessing game, even for probably the best educated, intelligent and knowledgeable finance professionals of Wall Street.
The former Secretary of Defence under the President Bush Jr. administration, Donald Rumsfeld, once distinguished, albeit in a completely different context, between the “known knowns”, the “known unknown” and the “unknown unknowns”. In halfway efficient markets, the “known knowns” are probably all priced in the current stock prices while the “known unknowns”, like political changes, trade wars, monetary policies, direction of oil prices can be analysed. As humble investors, we would however argue that we find it extremely difficult to get these factors right. For the “unknown unknowns”, the so-called black swans, they are by nature unpredictable.
Where does this leave us as value investors?
First, we save a lot of time by not even trying to forecast markets in the short run. We are guided by the principle that stocks are ownership fractions of a business. Market puts a price on these stocks on a second by second basis. We invest when we spot a significant margin of safety, or discount, of the stock price to what we think the business is worth. In our analysis of the business, we look of course at the operational environment the company is in and try to understand the impact of the “known knowns” and “unknowns” on these businesses and ultimately their capacity to deliver earnings to us as shareholders. We have a long-term investment horizon and are able to “sit out” the short-term volatility and remain firm in our investment decisions. We are convinced that investing in a portfolio of significantly undervalued but solid businesses creates value over time. That is completely different than trying to forecast the market for the next 6 months and position the portfolio accordingly.
Léon Kirch, CIO & partner, European Capital Partners