Crudeprices,systemthinkingandDanielKahneman

We live in a world of information overload, there is a constant chatter of seemingly important information which is round the clock hitting the airwaves. There are comments by central bank committee members, government ministers, businesspeople, survey results which we will hear during the course of the day. Then there are hard data points on how the economy actually fared; PMI, CPI, car sales, tax collection, unemployment, wage increase which also need to be reconciled. Is it even humanely possible to keep track of all these disparate points? For example today we will have the GDP number and unemployment claims in the US, monetary policy decision in the UK, IFO data in Germany alongside multiple Fed official speaking to the press and not to discount the ever mighty twitter is also present where every important person can broadcast their views.

To borrow a term from the US Fed Chief Jerome Powell we need to be humble regarding our ability to forecast. But what is the best bet? To answer this question, we need to take a broader systemic approach. Nobel laureate Daniel Kahneman in his book Thinking fast and Slow introduces us to a native (ingrained) fallacy in the way our mind works while taking any call (decision). He writes that the answer to any query can be approached in two ways first is an inside view and second is an outside view.

The inside view is the natural view, what do we know about it, how are we feeling about it, our response to the question will be guided by our own experiences. The outside view on the other hand asks if there are similar situations which can provide a statistical basis for making a decision. Are there any other people who faced similar problems and if yes then what happened? The outside view doesn’t come naturally as it asks us to abandon the belief that our information is complete. This is what happens in the markets, sometimes (almost in fact) we make predictions on the basis of what we know. The assumption is that what we know is complete, sadly that is not the reality. Our information apart from being incomplete is beset by the biases which we carry. Our reading is not eclectic, our sources are not multiple. However, markets give us the salvation in providing the outside view on a real time basis. The prediction which is generated by any market (which is deep, liquid, well participated) will be better than your individual forecast.

For example, think about the crude prices, market at any time is showing the crude futures traded prices which incorporates all the possible information (US weather, stockpiles, ME tensions). Unless you firmly believe that you have a unique edge or unique information or a unique understanding, there is hardly a reason to doubt the ticker. The market price is the ultimate outside view. But the caveat, markets can be dislocated and irrational sometimes but that is more an exception than a norm. If you have identified such dislocation than kudos to you. There is an entire private equity industry which works and thrives on this belief of identifying dislocations.

Having philosophised enough let us get back to the important events of the day. BOE announcement would be parsed for any hawkish signal, the UK economy is not the representative factor for the world unlike the US hence the interest would be more in listening about their views on structural inflation and employment. Post the US jobless data, we will discuss the issue of employment tomorrow in our note. The idea is to develop a unique understanding which refines an inside view which is lesser prone to errors. By the way, the brent crude near month contract is trading at 75.25 $/bbl. This is highest since May 2019, Indian bond markets, please take note.