FY 2022 Update – History lessons, Future predictions, Luck or Skill: does it all really matter?

"Investing is not hard science. It's many people making imperfect decisions with limited information about a complex system that will have a massive impact on their wellbeing, which make people nervous, greedy, and fearful."
- Morgan Housel. The Psychology of Money

"It seems to me that a significant portion of all the money investors made over the last 40 years resulted from the tailwind generated by the massive drop in interest rates. I consider it nearly impossible to overstate the influence of declining rates over the last four decades."
- Howard Marks, co-founder of Oaktree

"There is nothing permanent, except change."
- Heraclitus, Greek philosopher ~ 500 BC


It was a challenging year in many ways, and the stock markets had to digest a significant shift in interest rates, which negatively influenced almost all asset values. 2022 is now over, and I can lock this year up in the far corners of my memory where it becomes history and hopefully sits still and does not come back to haunt me.

I don't feel very much like writing. Some people have written eloquently about writer's block, and most say to give it time and effort, but mine has lasted for quite a while. I cannot find my writer's Mojo; there seems to be so much pessimism. Staring for prolonged times at an empty white Word document is not for the faint-hearted. I need to get creative as well as lucky and find something interesting, or I will start to think I lack the skill to write.

Both luck and skill play essential roles in various activities and endeavors. In some cases, chance may be more critical, while skills may be more significant in others. It depends on the specific context. For example, luck may play a more prominent role in determining the outcome in games of chance, such as lottery or gambling. In these cases, randomness largely determines the result, and skill may not have as much influence.

In activities that require a certain level of expertise or training, skill is often more critical. For example, in sports, the outcome of a game may be influenced by factors such as the players' physical abilities and the strategies they use, which are determined mainly by their skill and training. In a profession, an individual's success may depend on their knowledge, experience, and ability to apply those skills in a particular setting.

Overall, both luck and skill can play essential roles in different situations. Recognizing and acknowledging each role in understanding and approaching a case thoughtfully and effectively is critical.

Yes, sorry, I apologize. To be honest, I did not write the last three paragraphs myself; I admit it. Instead of dealing with my writer's block, I played with ChatGPT, an Artificial Intelligence (AI) model that generates a dialogue. I cued the model to write a few paragraphs on luck and skill. Did you notice it or not?

So, what worries me is the lack of skill I needed to produce three paragraphs with the help of AI. What should worry many knowledge workers (and teachers) is that these AI-driven models can take over skilled tasks in many ways and forms and are quickly getting exponentially better.

You see, our perception of the world is shaped more by personal experiences than whole libraries full of content or good education. Your place of birth, your family constellation, your upbringing, and your own life experiences shape your worldview, but let's be honest: this is probably less than 1% of what the real world looks like.

Your place of birth, the parents you are born to, rich or poor, whether you lived through a depression or lived in the booming 90s in your twenties, makes a significant difference in how you view the world today and how you manage risk and fear. AI uses large amounts of data, stripping out (hopefully) most of our biases as individuals. A highly skilled AI model running on large clean datasets can effortlessly outperform almost all skilled knowledge workers. This will undoubtedly bring many significant changes in how we live and work.

It was, according to Google, only 300,000 years ago that the first Human Sapiens sat somewhere around a campfire, which is only about 400 to 800 generations back. There were only a few thousand of us around. What? Roughly only 400 grandparents ago, we, as humans, did not even exist. How we went from roaming the prairies with a few thousand of us to an expected 10 billion in 2050 in such a short time is for another blog. From telling stories around a campfire as a form of cloud memory to AI in such a short period is an outstanding achievement. We are a very inventive lot, and there should always be room for optimism. We invented currencies and stock markets and, two generations back, developed retirement programs. We used to work until we were no longer physically able. Now we are talking about 4-day workweeks, and who knows, if AI works well, maybe even less.

Where does it all go? Is it necessary to know history to predict the future? I wonder what we can learn from it when profound changes in our lives are taking place in such a significant way at an unprecedentedly high speed. I think History's patterns are essential: we have seen profound changes in history, and we should be aware of them to understand the current state of affairs. Change is highly likely.

And what about the slow changes, the ones we read about but do not understand fully, like rising temperatures? We know from complex systems that a small change can tip the scales significantly and surprisingly. Compounding is a compelling force. A compounded 2% yearly increase in global temperatures will become a solid force over time. I just don't know much about the things I never experienced first-hand, let alone read about. I prepare and train myself to be flexible and open-minded, ready for change. I think being open to change is crucial when events seem to accelerate. It is not easy to do, but there is no choice other than to accept it: change is a constant, and I need the skill to be flexible to react quickly if necessary.

As with everything, the catalysts of change lie in the far end of the tail of a distribution: unexpected events. Those events are the ones that often tip the scale in a significant way, both negatively and positively: sharp changes in interest rates, wars, major meteor impacts, nuclear fusion, you name it. They will constitute significant changes in our world. Are you ready?

Higher interest rates…

Yes, with higher interest rates, change has been happening for a while. We have written about the influence of interest rates many times. We also wrote about the bloated asset values because of zero and even negative rates. Now, change has come: asset prices are under pressure, and the Fed's balance sheet is unwinding. It will be a long process. We have lived for four decades with lower interest rates resulting in major assisted asset growth. This trend has now reversed. It will be more challenging work from now on. This is not to say we cannot make headway and grow our portfolio. Of course, we can. It just will require more effort and a bit of luck.

That is why it makes sense to stay invested in companies like C3.Ai, which will have an excellent chance to outgrow and outpace the adverse environment. It makes sense to invest a small portion of our portfolio in an idea that has the potential to act like the small catalyst to tip the scales of our total portfolio performance, like a positive tail event. A company's value currently hardly has any embedded option value. It does not make sense to me, but I am not the market. I see AI exploding in the next five years, and C3.Ai will be a significant beneficiary. We foresee the implementation of C3.Ai models in many companies to explode in the next few years, both because its models are getting better every day and because AI models' acceptance rate and value will become evident. I will be patient.

By the way, it is still me writing, not ChatGPT!

Change is a constant, including in China, where we are invested in some of the biggest names listed. It has been a horrible ride in 2022 for all the reasons you already know. We foresee a return to growth and value in 2023. China's most prominent companies are cheap compared to the USA and Europe, partly for valid reasons, but fear has gone too far. We foresee a much more positive future environment knowing what we know today. BYD continues to outgrow just about every car maker in the world; Alibaba, Baidu, and Tencent all have significantly undervalued assets and are expected to return to growth in 2023. There is no race to the bottom, and 475 million households in China (130 million in the USA) keep on consuming every day. They cannot all be wrong.

Our own simple AI models at i-Cthru are doing their work in our quantitative strategy. We have no reason to tinker with them, although I would love to explore a ChatGPT version where we could read numbers and significant amounts of text in the annual reports. We will keep you updated.

There are many moments when we ask ourselves what actions we should take, especially when we see daily/ hourly prices going up or down. When prices go up, most of us usually get the urge to join the herd and buy. When prices crash, we panic and want to sell. In these extreme situations, we have limited resources in our brains to help us. It is called a scarcity mindset: we need to act now in fear of missing out. This urgency clouds our decision-making and is often driven by very primal instincts. To reach better decisions, it is best to slow down, talk to yourself as if you were talking to a good friend, take the emotions out of the equation and contemplate the facts.

We should only buy the best opportunities we understand and align this with the risk we think we are taking. We should only sell our high-conviction investments when there is a material change in our investment thesis or a better opportunity. Long-term high-conviction investments make it much easier to resist short-term decisions and ignore short-term price falls. Amazon's share price fell three times more than 50%, and during the dot.com crash dropped 90%. It would have been a lost opportunity to have sold it. Most successful companies' stocks trade below their highest price more than 95% of the time.

It pays to fight our biases like overconfidence, confirmation, and recency biases and to keep our emotions in check. Be patient and invest for the long run. Read a lot, confirm your process, keep an open mind and, above all, be optimistic. Ultimately, change is good, history is a good teacher, the future will be full of surprises, and we can use AI’s skills to be better prepared, which is fantastic because luck favors the prepared mind.

Thank you for your trust in us.