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FORECASTING FALLICIES

The most damning evidence of poor investor behavior is that our biases have persisted despite technological and economic progress across centuries. One of the most common errors we make as investors is believing in our own predictive abilities, or those of others. This post explores the limitations of predictions and the reasons why we often rely on flawed forecasts.

Take, for example, a 1931 book that could win first prize for the World’s Pettiest Book: Oh, Yeah? by Edward Angly. I first learned about this hilarious book in my 2021 interview with Marc Andreessen, and now I think every investor should have a copy on their bookshelf. Why? Because it serves as a reminder of how little we know, especially in regards to predictions.

In this short book, Edward Angly simply lists endless quotes from leaders in business, finance, and government about the strong state of America’s economy… right before the 1929 Crash and Great Depression. Following each set of quotes, Angly cheekily adds the comment, “Oh, yeah?”

Just to list a few of the freezingly cold takes in Angly’s book…

“There is no reason why there should be any more panics.” — Magnus Alexander, President, National Industrial Conference Board (1927)

“This is truly a new era in which formerly well-established standards of value for securities no longer retain their old significance.” — VP, Cleveland Trust Co. (August 15, 1929)

“There may be a recession in stock prices, but not anything in the nature of a crash.” – Irving Fisher, Economist (September 5, 1929)

“Stock prices have reached what looks like a permanently high plateau.” – Irving Fisher, Economist (October 16, 1929)

Oh, yeah?

The other problem with predictions is that we often fail to anticipate the transformative events and innovations that do happen. For instance, I recently came across this tweet (AI Grant is a company that Nat Friedman, a former CEO of GitHub, and Daniel Gross, a former head of Apple’s AI, founded):

It’s a bitter irony: we frequently predict events that never transpire and are unprepared for the events that do shape our world.

So, why do we do this? Why do we make impossibly difficult predictions and/or believe the predictions of so-called experts? I think the answer comes down to two issues.

First, investors loathe uncertainty because it introduces risk and threatens their sense of control. Predictions of the future offer a semblance of security, allowing them to make informed decisions based on what they believe will happen.

Second, humans have a natural inclination to trust authority figures and experts. We tend to attribute superior knowledge and understanding to them, which leads us to accept their predictions without questioning or analyzing them. Just think back to how regulators and politicians praised Sam Bankman-Fried for promoting responsibility in the crypto space!

THE POWER OF NARRATIVES AND CONVICTION: BLACK THURSDAY

Richard “Dick” Whitney

This second element is especially critical, as authority figures’ actions can have a huge impact on market movements and investors’ decisions. I recently began reading Taming the Street, which chronicles FDR’s regulation of Wall Street following the 1929 crash. The opening chapter offers a detailed account of acting NYSE President Dick Whitney’s actions the morning after Black Thursday.

As the market crumbled around them, a group of prominent Wall Street financiers gathered nearby to strategize and find ways to alleviate the situation. Dick Whitney was called to this meeting and ducked out of the NYSE without detection to make his way across the street to J.P. Morgan’s offices. Ultimately, this group of financiers pledged millions to prop up the market in blue-chip stocks like U.S. Steel.

With significant capital to deploy, Whitney confidently strode back into the NYSE and beelined for Post No. 2 (where steel stocks traded) on the exchange floor. As a sign of strength and confidence, Whitney placed one of the most famed orders in market history: “205 for [U.S.] Steel”. Whitney continued to walk around the exchange floor placing large bids for blue chip stocks at above-market prices. This New Britain Herald excerpt from October 25 offers a glimpse into the events of that day:

While his actions did not prevent a continued selloff the following week, Whitney’s public display of confidence on the NYSE floor temporarily stemmed the bleeding, and even sparked a brief rally into the weekend. Whitney became a hero, dubbed “The Great White Knight of Capitalism.”

THE “GREAT WHITE KNIGHT”: CHINKS IN THE ARMOR

Diana Henriques noted:

“The story of Whitney’s glorious march across that panic-stricken trading floor grew in the retelling… He was applauded within the exchange, saluted outside it. Whitney had become famous ‘quite literally overnight,’ and the media spotlight that found him on Black Thursday 1929 would follow him for the rest of his Wall Street career.

‘All that he did henceforth was to have a touch of magic,’ one journalist wrote a few years later. ‘The way he smiled, the look in his eyes, his merest wisecrack-all were to be noted and related’.”

The great irony, however, was that Whitney had a pretty poor investing track record. In fact, investors would have been wise to ignore his words after 1929, not hang onto them as gospel.

Whitney was fond of get-rich-quick schemes and moonshot investments. Making matters worse, he also heavily borrowed money to fund his investments. Throughout his life, the Wall Street legend owed a lot of money to many different people, including his brother George, who worked at J.P. Morgan.

His most ruinous venture was an investment in Distilled Liquors, which produced a brandy known as Jersey Lightning. Whitney believed that this liquor would be a smashing success post-Prohibition, and helped the company go public through an IPO. With borrowed funds, Whitney then hoovered up 15,000 shares of Distilled Liquor stock at $15.

As it turns out, Whitney’s thesis was partially right. An article from Novel Investor stated:

“The end of Prohibition brought about a boom in liquor stocks. In less than a year, Distilled Liquors’ stock shot up to $45. Whitney bought all the way up. Had he sold at $45, he could have paid off all his outstanding debt, with the exception of what he owed his brother. Instead, he held on, convinced it would go higher. He was all in.

$45 was the top.”

Over the course of two years, the stock price fell to $11. Whitney still had not sold a single share, and used the stock as collateral for new loans to support Distilled Liquor’s share price. He mortgaged his homes, embezzled clients’ money, and even took $1 Million from the Stock Exchange Gratuity fund.

Ultimately, Whitney served three years in Sing Sing prison and Distilled Liquors went bankrupt.

Whitney leaving prison

The story of Dick Whitney is a powerful reminder that even the most famous “experts” and national figures are not immune from bad judgment. So, what’s a good lesson for investors to take from this? It is bad judgment to take stock in other’s judgement.

Interestingly, the magistrate at Whitney’s trial warned:

“My little experience in life has been that it’s a whole lot easier to make money than to hold on to it, even in hard times. I guess that applies to all of us.”