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Unconvinced by the Dismal Science

Updated: May 20, 2022

Recently I was passed an article written in 1991 by the late Isaac Asimov about economics. Asimov, a polymath best known for his science fiction writing, simply could not understand "the dismal science" and I must admit neither can I. "People may say they understand it and economists even win Nobel Prizes, but I think it's all fake", he wrote. Indeed, people do more than just say they understand it; they base important investment decisions on it. If Asimov was right, much of my cherished industry is just one big con, but thanks to Mr Madoff et al this would not come as a huge surprise to many right now.

"We have become an industry of gamblers, believing that it is possible to get something for nothing"

Asimov told of a bet between two economists about the future of commodity prices. One said the cost of certain key metals would rise over the next ten years, because he felt that rising population and the declining availability of resources would make that inevitable. The other said that the cost would decline because of advancing technology and because the higher the population the better-off the world would be.

Asimov was "naturally" on the side of pessimist and was shocked to find that he'd lost the bet. To him it was obvious that a steadily rising population is deadly. "If basic com­modities are going down in price, what is it that's going up and drowning them out?" he asked.

Nor could Asimov understand why the American public is so opposed to higher taxes but be happy instead to have their wealth eroded by the payment of tax free interest on bonds issued to those who can afford them. It seems that many lower- and middle-income groups in America do not appreciate that government borrowing hurts them more than taxation would, as it simply directs more income away from them (the state) to the wealthy.

My own issue with economics is that it masquerades as a science. Most sciences make sense to me. Formulae can tell us precisely how long it takes an object to fall to earth or what happens if we mix zinc with sulphuric acid. But economics is a science that claims to be able to predict the future, to predict how people will behave at a certain time under certain conditions.

I myself am fairly well organized but I certainly cannot tell you how I will be feeling three months from now, so I'm pretty sure no one else could. A formula to say what my spending urges are going to be in June is, frankly, absurd. Economics, unlike physics or chemistry, will always have two formulae. One that gives one answer and one that gives the opposite. Commodity prices may or may not yield to gravity. Shares can go up as ,1·well as down.

So, if not economics, what investment tools do I use?

What I try to do is to apply some common sense to the world around me, and to keep things simple. It seems to me that much of the investment community has tried to understand the world through the use of more and more complex models. But the world is so complex that no model that we are capable of building will ever be able to explain how it works. In fact, paradoxically, we will never be able to build a model that explains the world as such a model would have to contain the model itself, which would have to contain itself ad infinitum, an impossibility, so we should stop trying.

The most dependable way I have found of predicting the future is to postulate that someone who is reliable today - and has been in the past - is likely to be reliable long into the future. If such a person is involved in running a company, chances are he will make some pretty sensible decisions in the meantime, enabling the company to generate profits in excess of its cost of capital. It helps if said company is in a higher growth industry but that's not so important to me. I'm just looking for steady companies run by steady people that I'm happy to entrust my and my clients' money to for a long time.

In fact this, to me, is what investing is all about, something my industry and its customers have lost sight of in recent decades. No one asked how Icelandic banks were able to offer higher rates of interest on deposits. No one asked how Bernie was able to produce high returns with low volatility, the equivalent of turning base metals into gold. We have become an industry of gamblers, believing that it is possible to get something for nothing. It's not. You can get high returns - by investing in great businesses - but the price to pay is that you'll never know when the share prices are going to perform and, in the meantime, they will move around wildly.

It has saddened me to watch my industry become more and more short term in recent decades - the average stock holding period in the US has, according to Société Générale Research, fallen from seven years to seven months in the last 50 years. But for the first time in a long time I am optimistic that the next few·years will see a reappraisal of what investing is: looking for sound businesses run by sensible people and sticking with them when you find them.

From 1930 until the mid-1940s, the average stock holding period in the US rose from one year to nearly 10 years. So we have precedent on our side.

Published in The Asset magazine

The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.

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