A Random Walk to a Known Destination

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Such was the success of the last Badger Blog, ‘The Art of the Impossible’ that honestly, it’s been daunting to follow it up with something of comparable quality.

It must be acknowledged however that a few readers were left a trifle puzzled by the long, long explanation of how a simple maths puzzle could be analysed and a certain Mr RC did indeed comment at a recent meeting that he wasn’t sure “what the heck that was all about”. My answer to his question was mumbling and inarticulate and on reflection I can see that the point I was attempting to make may indeed have been a tad opaque.

So, what was it all about and was it making a useful point?

Our job beyond the advice on financial management options (planning etc) is to work with clients to invest their funds in the ways they feel comfortable, to grow them as strongly as possible, ideally in excess of the average and natural growth of markets in aggregate.

This is what all money managers, investment companies and financial types in general say they can do. Give it to us and we’ll do better than anyone else (basically).

The vast majority of money managers and advisers justify their claim by suggesting that they have a level of understanding of all current matters, that allows them to correctly handicap the likelihood of future events and therefore ‘be on’ the next winners.

The point of the first blog was to examine this claim both in terms of the outcome of a maths experiment but more profoundly to realise from their failure that actually it wasn’t that they in general can’t do it, although they can’t, but that in-fact it’s mathematically undoable by anyone. This is because it’s not just necessary to correctly guess what happens but also then how these multiple occurrences interact with each other, which is impossible over shorter periods.

Therefore, this leads us back to the observation by Sherlock Holmes that “if everything that it can’t be is eliminated then what remains is what it must be”.

So, what does this mean?

If we take the analogy of predicting a child’s eventual adult height to illustrate this point, then there are a number of fairly accurate ways this can be done from birth onwards. It’s not an exact science but fundamentally the genetics of the parents is the main initial factor and then there will be ongoing societal inputs (quality of food etc) which will also have an effect.

What can be known is that if you want to invest in tall adults, then identify children with tall parents living in prosperous societies, who will be fed nutritious food and are generally well nurtured.

All children will grow, as indeed all markets will rise over time, but the outsized growth of a few is predicated on certain quantifiable attributes and inputs.

But!

Knowing this still does not make it possible to predict the pattern of growth over shorter periods of time. To use the same analogy, if investors try to predict growth between say the ages of 11 and 12 then this is just a guess. This period may produce a growth spurt but there is no way of knowing it will.
The potential height at the end can be fairly accurately known (share price) but not how and when it will be achieved over shorter time frames.

‘It is a random walk to a known destination’

If growth is the attribute an investor desires, then how humans grow is quite comparable to what creates the same effect for a company.

  1. Small (young) companies will grow more than mature companies. The largest companies such as Microsoft and Amazon come up against the “Law of large numbers” which sounds grand but basically just means that growing from 10 to 20 (100% growth but requiring an increase of 10) is much easier than growing from 1 Trillion to 2 Trillion. In Amazon’s case, to create another Amazon to double its size and it’s big already
  2. The more nutritious the food the more the likely growth, which equates economically to greater market opportunities and the ability to have pricing power. So, this would be found in the areas of technology, healthcare, AI etc and not in Supermarkets, Banking and Consumer Staples (Soap and toothpaste etc). These are mature markets where growth is not organic but achieved by lowering prices to alter the slice of a fixed sized cake
  3. The opportunities in certain markets will allow for greater growth. So, operating in Europe which is slow growing will be less nourishing than Asia or the US which are much more dynamic, nurturing environments

Conclusion

The best analogy about how to understand and react to the movements of markets is to equate them to taking a dog for an extended walk to a known destination on a very long lead.

The dog will go all over the place, but you end up where you wish to arrive at as long as you ignore where the dog goes.

To finish with a quote from John Wooden who was an enormously successful basketball coach with UCLA.

He was asked by a reporter:

“Coach Wooden, you have the golden touch but is there something in basketball you can’t coach into a player?”

The coach replied:

“Height, I can’t coach height”

Note: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.

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