Hunt: Chaotic System
Kotok: A Permanent Shift Upward
Krugman: Return to Normalcy
Rosenberg: Pretty Late in the Game
Wien: Speculation Reaches an Extreme
Jet-Lagged in Hong Kong, Sarasota, and Boston
Photo: Getty Images
In last week’s letter, “Economy on a Roll,” I gave you my own fairly upbeat 2018 forecast. I think the US economy and markets will probably hold up well, thanks to tax cuts and deregulation – assuming the Federal Reserve gets no more hawkish than it already has. That assumption may be a stretch, given the Fed’s changing composition, but I’m feeling optimistic anyway.
The one real potential wrench in the works that I did not mention last week was Trump’s actually enacting significant tariffs or tearing up NAFTA, which would cost millions of jobs and cause significant backlash. I am hopeful that mistake won’t be made.
This week and next we’ll look at forecasts from some of my most trusted friends and colleagues. I have so many that our project may even stretch into a third week. Some disagree with my own views – and that’s perfectly fine. I want you to see all sides so you can make good decisions for your own family and portfolio. I’ll let these forecasters speak for themselves in longer quotes than I usually allow, then add my own comments.
Before we start the trek, I want to mention that we’re closing the doors to the Alpha Society soon – on January 15, to be exact. While my instinct is to always keep doors open, the Alpha Society needs to stay exclusive in order to thrive. I talked about it in a two-minute video we recorded over the holidays. Please do me a favor and watch here.
I am looking forward to meeting many of my Alpha Society and VIP members in Hong Kong this Sunday late afternoon/evening. I always find such times to be great learning experiences.
Let’s start not with a forecast but with an important story about forecasts. It appeared on Ben Hunt’s always-excellent Epsilon Theory site last month, in a piece he titled “The Three-Body Problem.” Keeping it in mind as I read the various annual reports and year-ahead forecasts has proved quite helpful.
Ben’s wide-ranging essays are hard to summarize or excerpt in a way that captures their breadth and depth. I’ll give you a tiny snippet; but please, set aside some time this month to read the entire article. It is long but worth your while.
The Three-Body Problem is a famous example of a system which has no derivative pattern with any predictive power, no applicable algorithm that a human could discover to adapt successfully and turn basis uncertainty into basis risk. In the lingo, there is no “general closed-form solution” to the Three-Body Problem. (It’s also the title of the best science fiction book I’ve read in the past 20 years, by Cixin Liu. Truly a masterpiece. Life and perspective-changing, in fact, both in its depiction of China and its depiction of the game theory of civilization.)
What is the “problem”? Imagine three massive objects in space … stars, planets, something like that. They’re in the same system, meaning that they can’t entirely escape each other’s gravitational pull. You know the position, mass, speed, and direction of travel for each of the objects. You know how gravity works, so you know precisely how each object is acting on the other two objects. Now predict for me, using a formula, where the objects will be at some point in the future.
Answer: You can’t. In 1887, Henri Poincaré proved that the motion of the three objects, with the exception of a few special starting cases, is non-repeating. This is a chaotic system, meaning that the historical pattern of object positions has ZERO predictive power in figuring out where these objects will be in the future. There is no algorithm that a human can possibly discover to solve this problem. It does not exist.
And that of course is the basic problem we have in economics and investing. When we say that past performance is not indicative of future results, that aphorism is more than just legalese.
I’ve written before about chaos theory and complexity economics. Such ideas can easily discourage us from even thinking about the future. Ben Hunt explains why that’s not the right response. The real answer is to think about the future differently.
With that prelude, let’s move on.