The paradox of prediction

• Many long-term predictions are reliable; many short-term predictions are not.
• The cost of many technologies is falling predictably and exponentially.
• Focusing on long-term change is therefore less ‘speculative’ than is often assumed.

Not all forecasts are created equal. Predicting when the sun will rise, for example, can be done with absolute precision far into the future. The long-term weather forecast is far less predictable – albeit meteorological supercomputers now allow us to make reasonably accurate forecasts about what will happen in the short-term. Climate forecasting, by contrast, is useless in helping us to decide if we need to take our umbrellas to work tomorrow – but it has proven to be very reliable at predicting the long-term effects of human activity on the climate.

Humans have a bias towards short-term forecasts

As humans, we draw on our past experiences to make conscious and unconscious forecasts every day. Most of those experiences fall within a standard range or ‘normal distribution’. This means I can confidently predict that it won’t be 40⁰C in Glasgow tomorrow. 

Most of our conscious predictions are like forecasting the weather (normally distributed and short-term). Unfortunately, this creates a problem: it gives humans an intuitive bias towards the short-term. As a species, we tend to view long-term forecasting as hard – perhaps even as being arrogant or pointless. But in actual fact, as with climate forecasting, some long-term predictions can be surprisingly accurate and incredibly valuable.

Stockmarkets are difficult to consistently predict in the short-term 

Financial markets are complex adaptive systems. They are driven by emotions as much as by information. They are not efficient and their returns are not normally distributed. Despite this, a huge amount of analytical time and money are devoted to trying to forecast ‘the next print’, be that inflation data or company results. Yet despite the application of computing power and human resources that dwarf those available to the Met Office, short-term financial forecasts remain woeful.

Even central bankers are terrible at making short-term financial forecasts

Long-term change is predictable

But if financial markets are unpredictable in the short term, the initial conditions surrounding us today make certain long-term developments extremely likely. For example…

• computing power
• data storage
• solar panels
• wind turbines
• genome sequencing
• battery energy storage 

…will all continue getting cheaper at highly predictable rates over the next five-to-10 years, driven by Wright’s Law learning curves. 

In contrast, fossil fuels do not benefit from Wright’s Law; while prices of coal, oil and gas have exhibited huge volatility, there has not been any long-term downward trend in their cost. In fact, a paper published last year by the Institute for New Economic Thinking at the Oxford Martin School showed that, after adjusting for inflation, prices of fossil fuels today are roughly where they were 140 years ago…

This process of predictable long-term change isn’t confined to the energy transition. Software, machine learning and artificial intelligence will continue to ‘eat the world’. Many known technologies, meanwhile, will converge and create opportunities to innovate and solve significant problems such as climate change, biodiversity loss and education inaccessibility. 

This is all useful information to investors. It means we can confidently predict that many established industries will be disrupted and that most incumbents will struggle to adapt to technological shifts in the basis of competition. We can forecast (with appropriate margins of safety) that many of the companies that are building businesses around these structural transformations will create significant value for their shareholders – regardless of what interest rates or inflation are over the years ahead.

The costs of key underlying technologies are falling exponentially

Investing on the basis of long-term predictions isn’t easy

Like all investors, we need to find companies that can create value from these long-term trends as they unfold. When we successfully identify such companies, it will take time for compounding to do its work and for the market to appropriately weigh their value. In the meantime, perceived changes in a company’s ability to succeed will lead to volatility and put pressure on us to buy, sell (or hold) when we shouldn’t. Uncontrollable and unpredictable shifts in short-term sentiment will have a meaningful impact on valuations across the market – and on our portfolio.

If you stand for nothing, you’ll believe in anything

Despite these challenges, one benefit of investing in highly predictable long-term trends – particularly when you have a mission-driven, positive-impact perspective such as ours – is that they provide a deep keel and a true north when enduring the inevitable short-term storms that hit. 

• We do not know where oil prices will be later this year (or next year). But we do know that demand for oil will be capped at a lower level than it would be if electric vehicles were not becoming more widely available and more affordable with every passing year. 
• We do not know whether the US government will support meaningful healthcare reform and lower the cost of healthcare for its poorest citizens. Yet we can have a high degree of confidence that the falling costs of genomic sequencing and machine learning will dramatically improve cancer diagnostics, save lives and reduce the system-wide cost of cancer care. 
• We do not know whether the externalities of the fashion industry will be appropriately taxed by governments. But we do know that digital garment printing will continue to get cheaper and enable manufacturers to take significant waste and emissions out of the fashion economy.

It can be difficult to take a long-term view. But history shows that when the cost of a better technology undercuts an existing technology, its adoption will grow exponentially.  So whatever happens in markets over the short term, the long-term forecast is clear: companies that can harness better technologies to make a positive impact will prosper –  and those are the companies that we’ll continue to entrust with our clients’ capital.