Rabbits are an epidemic in New Zealand, wreaking havoc on the ecosystem due to the lack of natural predators. To solve this problem, someone came up with a brilliant idea of introducing a natural predator for the furry colony. Mustelids, ferrets, and weasels were imported to let “nature” take care of itself.
It backfired spectacularly. The predators turned their attention to native bird species—flightless birds like the kiwi, kakapo, and takahe were driven close to extinction, while the rabbit population continued to thrive.
A similar incident occurred in China during the Great Leap Forward. Concerned about sparrows consuming too much grain, the government launched the “Smash Sparrows” campaign to reduce their population. While the campaign succeeded, it led to an explosion of insect pests, decimating crops and contributing to a devastating famine. The sparrows, while consuming grain, also played a crucial role in controlling insect populations.
These examples highlight the danger of linear thinking in complex systems. It’s tempting to assume that a single action will have a single, predictable outcome (X leads to Y), but reality is rarely so straightforward. Every action has ripple effects, often referred to as second-order effects, which can be far-reaching and unpredictable.
The financial markets provide ample evidence of this.
Many predicted that rising interest rates would doom the stock market in 2023, yet it marched onward to new all-time highs.
Similarly, the swift rebound of the stock market after the initial COVID-19 crash defied widespread expectations of a prolonged downturn.
The economy is dynamic, with multiple moving parts. As Charlie Munger famously observed, “too little attention [is given] in economics to second order and even higher order effects. This defect is quite understandable, because the consequences have consequences, and the consequences of the consequences have consequences, and so on. It gets very complicated.”
The problem is that uncertainty is painful, and most investors can’t wait to gobble up tablets of forecasts and predictions to relieve their pain, even though they have proven time and time again to be unreliable.
Howard Marks cautioned against the need for certainty in his memo, “There simply is no place for certainty in fields that are influenced by psychological fluctuations, irrationality, and randomness. Politics and economics are two such fields, and investing is another. No one can predict reliably what the future holds in these fields, but many people overrate their ability and attempt to do so nevertheless. Eschewing certainty can keep you out of trouble. I strongly recommend doing so.”
I’ve previously discussed how to consider second-order effects here, so I won’t repeat myself. Instead, I’ll remind you: beware of investment advice based on political predictions or interest rate forecasts. The world is too complex for such linear thinking. Remember, investing based on predictions rarely ends well.
Investing, like health, thrives on the basics. Just as sleep, exercise, and diet are fundamental to good health, so too are buying quality businesses at reasonable prices and letting compounding work its magic for successful investing.
Compound steadily,
Thomas