The Certainty of Uncertainty

By Josh Wolfe

As Biggie said, “If you don’t know, now you know…”

A big philosophical kerfuffle consumed Lux’s NYC office last week. The debate? Uncertainty. Certainty. Risk. Confidence.

Uncertainty persists, always and everywhere. It is the only thing I argued of which you can be certain.

Take as example the market’s reaction to the Brexit vote for Britain to remain or leave — actually really focus on nearly every financial advisor’s note from nearly every firm sent to nearly every client the world over trying to resolve emotion of fear by explaining it tautologically with the phrase “heightened uncertainty”. That written phrase was widely followed by another sentence, an attempt at assurance and a plead against panic, that the financial advisor or its broader network had people “on the ground” following developments in real-time. Whew! Conjure image of men in long-tailed suits, with umbrella canes and bowler hats running around the streets of London whispering, running, trading rumors.

Here’s the thing:

• Before the Leave/Remain vote in Britain there was…uncertainty.
• After the Leave/Remain vote had a certain outcome, there was…uncertainty.
• Had the Remain vote prevailed, it would have been a certain outcome and there would have been…uncertainty. Why? Because while we can only conjure counterfactuals speculatively, with half the population possessed by populist protectionist right-leaning jingoism, who knows what uncertain event may have unfolded. Riots? A political assassination?
• Now with the Leave vote a certain outcome (cue dramatic piano chords and camera zoom: “Or is it?!”)

Who knows what happens next? So: uncertainty.

Those that made money especially global macro veterans, bet against the consensus odds. They found an attractive asymmetric discrepancy between the chances and the price. Low probability high-expected outcomes.

They followed the wisdom of Charlie Munger

The model I like — to sort of simplify the notion of what goes on in a market for common stocks — is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.”

They followed the wisdom of bridge player, economist and Harvard risk guru Richard Zeckhauser (see paper here)

They followed the wisdom of racing investor and handicapper Steven Crist

The central premise of pari-mutuel wagering, is to get a better price from the other bettors than something deserves to be….

Recognize the difference between picking horses and making wagers in which you have an edge. The only path to consistent profit is to exploit the discrepancy between the true likelihood of an outcome and the odds being offered.

Do you really think this way when you’re handicapping? Or do you find horses you ‘like’ and hope for the best on price? Most honest players will admit they follow the latter path. This is the way we all have been conditioned to think: Find the winner, then bet. Know your horses and the money will take care of itself. Stare at the past performances long enough and the winner will jump off the page. The problem is that we’re asking the wrong question. The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory. This may sound elementary, and many players may think they are following this principle, but few actually do. Under this mindset, everything but the odds fades from view. There is no such thing as ‘liking’ a horse to win a race, only an attractive discrepancy between his chances and his price.

Uncertainty is and always was a constant. What causes prices of assets and currencies to move is changes in expectations and specifically of people gaining or losing confidence in what they expect. There is no more or less uncertainty, only more or less confidence in a belief. The sum total of those beliefs is how something is valued, whether it is Tesla stock, a sovereign currency or a corporate bond. It is a subtle and maybe eye-rolling annoying nuance, but it is a distinction with a difference.

Everybody at Lux is indoctrinated with the philosophical truth that at any point of present, any moment of “now”, 100% of the information we have is based on the past and 100% of the value of the action we take on that information is based on the future which is inherently probabilistic and unpredictable. You can have strong beliefs loosely held, as is the scientific way. But uncertainty itself is like gravity, always present if not always felt and sometimes defied.

Certainty is an illusion or a delusion. Certainty is a comfort. Certainty is the narrative we tell ourselves that shines light powered by confidence on a path always and everywhere paved only with uncertainty. Certainty is true risk. Because risk is more things can happen than will. And confidence that you know for sure what happens next leaves you vulnerable to surprise. And surprise in individuals as in markets is what jolts new highs and new lows.