{"id":2406,"date":"2010-11-30T10:56:36","date_gmt":"2010-11-30T17:56:36","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=2406"},"modified":"2018-08-17T08:54:27","modified_gmt":"2018-08-17T12:54:27","slug":"solely-analytical-methods-are-doomed-to-failure","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2010\/11\/30\/solely-analytical-methods-are-doomed-to-failure\/","title":{"rendered":"Solely Analytical Methods Are Doomed To Failure"},"content":{"rendered":"

The Wall Street Journal has an article this morning entitled, “Economists’ Grail: A Post-Crash Model.”\u00a0\u00a0 The article demonstrates aptly exactly why I wrote my book, The Intuitive Investor: A Radical Guide for Manifesting Wealth<\/span><\/a>.<\/span><\/p>\n

You see it all comes down to this:<\/span><\/p>\n

There is no such thing as a future fact.\u00a0 Facts by definition are things that have already happened…in the past<\/span>.\u00a0 Yet investing is an activity that unfolds in the future.\u00a0 So facts and investing are actually at cross purposes from one another.<\/span><\/p>\n

But\u00a0“[f]or decades, most economists, including the world’s most powerful central bankers, have supposed that people are rational enough, and the working of\u00a0markets smooth enough, that the whole economy can be reduced to a handful of equations.\u00a0 They assemble the equations into mathematical models that attempt to mimic the behavior of the economy,” says the Wall Street Journal.\u00a0 I can attest as the retired co-portfolio manager of the Davis Appreciation & Income fund that this is how almost all investors, professional and amateur alike, go about making their decisions.<\/span><\/p>\n

The WSJ continues:\u00a0“In the wake of a financial crisis and punishing recession that the models failed to capture, a growing number of economists are beginning to question the intellectual foundations on which the models are built.”<\/span><\/p>\n

Unfortunately, even the questioning is still rooted in a paradigm that is incorrect.\u00a0 Note “the intellectual foundations” verbiage in the preceding quote.\u00a0 The problem is that researchers are looking for a solution within the bounds\u00a0of the\u00a0analytical left-brain, which happens to be the source of the problem to begin with!<\/span><\/p>\n

Human beings are well equipped to deal with the organic, multi-dimensional, future-oriented problems that confront every investment decision maker.\u00a0 Here I am speaking about the right-brain.<\/span><\/p>\n

Our right brains thrive in an organic, multi-dimensional, hyper-complex, future-oriented environment.\u00a0 Unfortunately, the foundations of our learning traditions in the western world have emphasized analytical methods for far\u00a0too long and to such a degree that the right-brain is ignored at best, and ridiculed at worst.<\/span><\/p>\n

Why are we so absolutely rooted in this way of thinking?\u00a0 It is because long ago the bedrock,\u00a0metaphysical, underpinnings of western thinking stopped being questioned.\u00a0 Here I am talking about the assumption that the only things that are acknowledged as real are those things that are endlessly replicable.<\/span><\/p>\n

What about the unpredictable?\u00a0 What about the truly exceptional?\u00a0 What about those moments\u00a0when everything changes<\/em> all at once?\u00a0 In the world of economics and finance those things that cannot be described mathematically and that\u00a0are not predictable are either rationalized away, or\u00a0are ignored entirely.<\/span><\/p>\n

I am not the only one who recognizes and has written about these massive shortcomings.\u00a0 Here is a quote from James Gleick’s book Chaos: Making a New Science<\/em>, that I also quote in my book The Intuitive Investor<\/span>:<\/span><\/p>\n

“The [mathematically]\u00a0solvable systems are the ones shown in textbooks.\u00a0 They behave.\u00a0 Confronted with a non-linear system, scientists would have to substitute linear approximations or find some other uncertain backdoor approach…When people stumbled across such things – and people did – all their training argued for dismissing them as aberrations.\u00a0 Only a few were able to remember that the solvable, orderly, linear systems were the aberrations.”<\/span><\/p>\n

Or, if you prefer, from the Wall Street Journal’s article, a quote from leading chaos-theory-as-applied-to-the-financial-markets researcher Doyne Farmer of the Santa Fe Institute:<\/span><\/p>\n

“A typical [model]…consists of anywhere from a few to dozens of interlinked equations, which must agree before the model can spit out a solution.\u00a0 If the equations get too complex, or if there are too many elements, the models have a hard time finding the point where all the [investors’] preferences meet.<\/span><\/p>\n

“To keep things simple, economists leave out large chunks of reality.”<\/span><\/p>\n

Look at the gap in time between James Gleick’s statement of 1987 and Doyne Farmer’s\u00a0talking about the same thing 23 years later in the Wall Street Journal; this is stunning!\u00a0 Despite the obvious shortcomings of analytical models people continue to look for solutions in the same, limited space.\u00a0 There are no needles in that haystack; I know because I looked my entire life for them, too; that is, until I realized that solely analytical methods are doomed to failure.<\/span><\/p>\n

So what sorts of solutions are being proposed even by those who understand the shortcomings of analytical methods?\u00a0 From Mr. Farmer himself, “…a proper agent-based model could take years to build…”\u00a0 In other words, let’s just increase the complexity of the mathematical models.\u00a0 Let’s just look for a solution in the same ground that we have already tread.\u00a0 How do you make a super complex model like this work?<\/span><\/p>\n

“The tough part is coming up with rules that bear some relation to reality…Writing better rules for human behavior will require researchers to dig deeper into the human psyche.”\u00a0 This is like pushing a string.<\/span><\/p>\n

Who determines the inputs that are worth putting into the computer model?\u00a0 A human-being.\u00a0 Who programs the computer that might evaluate which inputs are replicable and that are core to understanding human beings?\u00a0 That’s right, a human being.\u00a0\u00a0Who determines the methods that are appropriate to evaluate human behavior?\u00a0 Again, it is a human being.\u00a0 Underlying all of the smoke and mirrors of analytical methods, no matter how complex,\u00a0are human beings and human choices about what makes sense in terms of an evaluation or a method.<\/span><\/p>\n

Because mathematics is invented by human beings to serve those western world metaphysical postulates – only that which is replicable is real – mathematics is, by definition, a subset of the human being.\u00a0 That is, math is within<\/span><\/em><\/strong> the bounds of the human-being.\u00a0 Therefore, it is less than a human being’s capabilities.<\/span><\/p>\n

The only reason that math is believed as underpinning nature and natural functions, and therefore as the only thing that is real, is because we have created it as a tool to describe the only thing we have chosen to believe in: a linear reality.\u00a0 This is recursive logic.\u00a0 We\u00a0choose to believe\u00a0math underlies reality, therefore we only pay attention to those things described by math.\u00a0 All the while there is that inescapable brush with reality: math, by some estimates, describes well less than half of actual reality.<\/span><\/p>\n

Just as the analytical world’s advocates were on the verge of\u00a0recognizing the hidden absurdity of their\u00a0assumptions about reality, then\u00a0rode in on a white\u00a0horse\u00a0an armored\u00a0champion: behavioral finance.\u00a0 Behavioral finance is genius.\u00a0 It highlights the limitations of the right brain.\u00a0 Therefore, we can hold on to our analytical methods and ignore the assumptions underlying\u00a0our choices.<\/span><\/p>\n

Unfortunately though, behavioral finance can only demonstrate the limitations of the right brain when there\u00a0is in fact, a\u00a0known and quantifiable analytical answer.\u00a0 But there is no such thing as a future fact.\u00a0 Investing unfolds in the future.\u00a0 So we are stuck with the same pickle as before.<\/span><\/p>\n

But not everyone is drinking from the same punch bowl.\u00a0 From the Wall Street Journal’s article is this lovely quote from an economist, Roman Frydman:<\/span><\/p>\n

“The main flaw in the dominant models, he says,\u00a0is the same feature that makes them so attractive to policy makers: Their ability to make precise predictions.\u00a0 To generate their predictions, the models assume that people, firms and other players always make decisions in the same way.\u00a0 The players must also share the same belief about the exact probabilities of various outcomes, such as a rise in car prices or tax rates.<\/span><\/p>\n

” ‘It’s like socialist planning,’ says Mr. Frydman.\u00a0 ‘If we really knew that much, we could have Communism and God knows what.’ Capitalism works better than other systems, he says, because it lets people\u00a0disagree about the future and profit from their insights – rational behavior that models don’t accommodate.<\/span><\/p>\n

“Mr. Frydman doesn’t offer a better way to make predictions.\u00a0 Rather, he believes economists and policy makers must come to terms with the limits of their knowledge.”\u00a0 [Or their underlying assumptions.]<\/span><\/p>\n

Amen!\u00a0 Or maybe not.<\/span><\/p>\n

While Roman Frydman recognizes the limitations, his policy prescription is simply to change the laws\/regulations that control the game.\u00a0 His strategy is basically to limit the realm of possible choices in the real world to those that fall within the bounds of statistical methods to predict them.\u00a0 That is, he wants to eliminate the “fat tails” or extreme, unpredictable\u00a0swings of the real world.\u00a0 Effectively, he wants to legislate away reality and all of its non-linear sloppiness.\u00a0 Wow!<\/span><\/p>\n

Assuming that this is absurd then begs the question: what can be done?<\/span><\/p>\n

    \n
  1. Light must be\u00a0allowed to shine\u00a0on the underlying metaphysical assumptions of western thinking.\u00a0 Namely: only that which is forever replicable and describable by mathematics is real.<\/span><\/li>\n
  2. We must acknowledge that we cannot look for a solution within the same methodology that has created the problem, mathematics.<\/span><\/li>\n
  3. We need to recognize that math is a subset of human capability and only capable of describing\u00a0well that portion\u00a0of human beings and our world that is predictable.<\/span><\/li>\n
  4. We must acknowledge that the human being has a tremendous capability to assess the multi-dimensional, unpredictable world; that is,\u00a0our right brains.<\/span><\/li>\n
  5. We must enter this space without our usual mathematical tools and instead, enter it embodying the true nature of the scientist: an explorer of the uncharted.<\/span><\/li>\n<\/ol>\n

    So little work has been done to codify and systematize the right-brain’s abilities that most researchers and practitioners have abandoned work there.\u00a0 But the right-brain does respond to method.\u00a0 Most importantly, investment decisions made using its powers of creativity and intuition are quantifiably successful.<\/span><\/p>\n

    I hold up my professional investment career<\/a> as an example.\u00a0 I hold up my prediction of a global financial meltdown on October 21, 2004 as an example.\u00a0 I hold up my calling the March 9, 2009 market low on this blog on March 12, 2009<\/a> as an example.\u00a0 Each of these things was unpredictable by mathematics, but was predictable by the creators of mathematics, a human being.\u00a0 But the methods were creative and intuitive, not mathematical.<\/span><\/p>\n

    What is lacking in this super cutting-edge, boundary-busting realm is interest, patience, and language to describe the phenomena of the right-brain.\u00a0 That is exactly what The Intuitive Investor: A Radical Guide for Manifesting Wealth<\/span><\/a> does.\u00a0 It argues that a balance between analysis and judgment are the keys to effective decision making.<\/span><\/p>\n

    Jason<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

    The Wall Street Journal has an article this morning entitled, “Economists’ Grail: A Post-Crash Model.”\u00a0\u00a0 The article demonstrates aptly exactly why I wrote my book, The Intuitive Investor: A Radical Guide for Manifesting Wealth. You see it all comes down to this: There is no such thing as a future fact.\u00a0 Facts by definition are […]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[12,3],"tags":[],"class_list":["post-2406","post","type-post","status-publish","format-standard","hentry","category-best-of-the-blog","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/2406","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=2406"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/2406\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=2406"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=2406"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=2406"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}