The Perils of Prediction and the Principles of Investing
“Worrying about the future is as effective as trying to solve an algebra equation by chewing bubble gum. The real troubles in your life will always be things that never crossed your worried mind.”
– Baz Luhrmann
The Perils of Prediction: Two Articles That Stand Out
At the start of each year, financial forecasters confidently present their predictions, and every year, reality renders most of them (us) incorrect. Some miss by inches, most miss by miles. But the underlying problem is the same: financial markets, economies, and geopolitics are dynamic systems that resist simple models, linear thinking, and prediction. And, like clockwork, year in and year out, the complexity of systems makes a nonsense of forecasts about markets.
In trying to figure out how to handle this uncertainty, and what it means for investment decisions, there are at least two helpful guides. The first guide comes from looking backwards in time. By doing this we can see how easy it is to be wrong. And this shows just how difficult it is to anticipate what is coming. In essence, looking backwards tells us that the future is fundamentally unknowable. The second principle comes from a thought experiment. Imagine we are ten years ahead in time from now, and that we are looking back from 2035 to today. This travel through time can help our current selves imagine what might come to pass. Whilst abstract, this thought experiment can help us identify some of our more dangerous beliefs. And removing – or at least reducing – biases can help pull risk away from the opportunities we imagine in an unknowable future.
Helpfully, each of these exercises has already been done by others. This means we don’t have to start from scratch or re-invent the wheel in using these two guides in our investment decisions. The first piece of work comes from Bloomberg’s John Authers. At the end of each year, he writes an article for his imagined investment firm, Hindsight Capital, which makes fantastically astute decisions because they know – with the benefit of hindsight – what to buy and what to avoid. The fantasy shows just how hard it is to imagine what each year delivers because the greatest winners are almost always a surprise. The second piece of work comes from Cliff Asness, co-founder of AQR Capital Management, who, in a recent article leaps forward a decade, imagining the errors that will become evident in hindsight by 2035. More on each of these thought experiments below.
Hindsight Capital: The Market’s Greatest Illusion
“Every move you make, And every vow you break Every smile you fake Every claim you stake I'll be watching you”
– The Police
Knowing what the future is about to deliver makes investing easy. This is why so much effort is spent on predictions. John Authers’ annual report from Hindsight Capital serves as a powerful reminder that while it helps to know what’s coming, we generally don’t know what the future is about to dish up. The firm’s annual report shows that it is much harder to identify winners than you’d imagine. Or put differently, the investments that deliver the best results are hard to believe – and although Hindsight Capital knows, the firm’s investment team has an impossible time convincing investors what lies ahead.
Hindsight Capital’s perfectly timed trades for 2024 delivered staggering returns by capitalising on market results that few foresaw. The long-short strategy began with an overweight position in the Magnificent Seven – Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta – whose momentum propelled a 70.1% return. Arguably, this was an easy call and a popular, call. The fund then went on to short oil drillers, banking on the divergence between AI-fuelled tech and traditional energy stocks. The net result was a total return of 140.6%. Another blockbuster trade involved buying French CDS (credit default swaps) while shorting German CDS, generating a 94.7% gain as France's fiscal worries intensified.
Beyond equities, Hindsight Capital rode the commodity wave, going long on cocoa futures amid West African supply disruptions – yielding a staggering 242% return – while shorting soybeans, which faced oversupply. In emerging markets, the fund shorted the Brazilian real and went long on Argentine stocks, benefiting from Javier Milei’s pro-market reforms. This gave a 182% return. Meanwhile, an overweight position in Japanese equities, coupled with short bets against Chinese property developers, capitalised on Japan’s improving corporate governance and China’s persistent real estate strains. This produced a gain of 118%.
Fixed income also presented lucrative opportunities. Shorting long-dated US Treasuries while holding high-yield corporate bonds captured the widening yield spread, delivering a 77% return. Additionally, a short on European sovereign bonds, particularly UK gilts and multi-year Italian government bonds, amid heightened fiscal risks, secured a 105% profit. In currencies, Hindsight Capital’s long-dollar, short-yen trade capitalised on Japan’s hesitant monetary tightening, contributing a 68% return. Added together, Hindsight Capital‘s returns towered over the 17.5% gain produced by the MSCI All country World Index and the S&P500’s 25.0% return.
The key takeaway from Hindsight Capital? Even with perfect foresight, extraordinary profits remain theoretical luxuries rather than practical realities. Most people would have had a hard time agreeing to the above positions at the start of 2024 – and an even harder time holding them as the year evolved. In the real world, investors must navigate uncertainty, adapt to unforeseen events, and withstand volatility. More importantly, even if we possessed perfect foresight, the biggest winners would be nearly impossible to identify in advance – precisely because their success often defies logic, expectation, and prevailing sentiment.
John Authers’ playful exercise underlines the reality that no investor has the luxury of making investments based on a knowable future. Instead, investors must construct portfolios that can endure market turbulence, withstand surprises, and mitigate the impact of misjudged predictions. Those who abandoned discipline in favour of chasing stories and reacting to short-term noise are the ones who suffer most. How do we know this? Because investors don’t come close to matching Hindsight Capital’s returns.
"The herd instinct among forecasters makes sheep look like independent thinkers."
– Edgar Fiedler, The Three Rs of Economic Forecasting (1977)
Cliff Asness’ 2035: An Allocator Looks Back Over the Last 10 Years imagines how today’s most-favoured investment positions might be viewed in hindsight. From his fictitious 2035 vantage point, Asness looks back at his firm’s investment results and reports on how things went wrong over the past decade because of the misplaced investments that were made at the start of 2025. So, what went wrong between 2025 and 20235 for Cliff Asness and his clients?
Over-allocation to private equity, which failed to deliver superior returns once capital stopped flowing freely. What was expected to provide insulation from volatility instead mirrored public equity markets, but with higher fees and reduced liquidity.
The Magnificent Seven phenomenon, where today’s tech darlings ultimately faced valuation compression. Investors who believed these companies could sustain their high-multiple growth indefinitely found themselves exposed when interest rates normalised, competition intensified, and earnings growth failed to keep pace with expectations.
The collapse of speculative excesses in assets like crypto, which experienced brief resurgences before long-term declines. The institutional fear of missing out that led to late-stage entries at inflated valuations resulted in substantial losses when liquidity dried up and enthusiasm waned.
Private credit disappointments, as what was marketed as a low-volatility, high-return asset class turned out to be highly correlated with public debt markets, suffering under the weight of higher interest rates and rising defaults.
Hedge funds (long-short equity) failing to deliver, as their supposed downside protection was undermined by a strong correlation to equity markets, delivering little actual diversification benefit.
US-centric portfolios suffering, as the assumed perpetual dominance of American equities proved misplaced, and valuations adjusted downward in the face of sustained international outperformance.
And what did Cliff Asness and his clients miss over the ten years to 2035?
The resurgence of value stocks, which, after a decade of neglect, finally saw strong returns as stretched growth stock valuations corrected, and fundamentals once again dictated price movements.
International equities outperforming, particularly in markets that had been overlooked in favour of the US. As valuations converged, investors who had maintained global diversification saw significant relative gains.
The return of trend-following strategies, which were abandoned after a period of low volatility but proved invaluable in navigating a decade of market swings and dislocations.
Hard assets and commodities flourishing, as inflationary pressures persisted, and global supply chain realignments drove demand for energy, industrial metals, and other real assets.
Government bonds outside the US, which provided attractive real yields and stability in select global markets, while US Treasuries struggled with mounting fiscal concerns.
This retrospective warns against the illusion of safety in popular trends. Many investors and market commentators today are confident in their assumptions about AI’s continued dominance, private equity’s resilience, the sustainability of tech’s outperformance, and the endurance of the American economy under Trump, the dollar, and US equities. The reality, Asness argues, is that investing based on recent winners is rarely a winning strategy in the long run. And even more problematic for trend followers and sentiment huggers is that what most-often works in the long run are investments that are out of favour, unloved, and on undemanding valuations. But this makes these assets hard to own, and emotionally easy to avoid. This is exactly the wrong way around.
The US Equity Rally: How Long Can the Party Last?
"All excesses are ultimately punished."
– Charles Kindleberger, Manias, Panics, and Crashes (1978)
What to do with the results of these two powerful exercises? The S&P 500 surged 25.0% in 2024, following a 26.3% gain in 2023. This pushed US market dominance to make up almost two-thirds of global equity market capitalisation. In many settings, the stellar performance of US equities in recent times makes it hard to argue a case for moderating exposure to the world’s biggest market and most-owned companies. With the benefit of lessons from the past, it might make sense to think even harder about positions that are popular and obvious. How much longer can the bull market in US equities last? What happens if Trump’s make America great again (MAGA) policies whimper or if maganomics fails? What happens to the most popular investment positions listed by Asness if we aren’t going into a golden age under Trump, but instead into a great reset?
In investing, across all markets, and through all times, there are two fundamental principles that underpin successful results: (i) buy “good” assets that withstand setbacks and endure shocks, and (ii) pay a good price for those assets. Good assets bought at a bad price are bad investments. Bad assets bought at a good price are speculative. We are in search of good assets at a good price. Applying this thinking to the most-loved asset class is a good point of departure in thinking about what 2035 would say about 2025’s investment positions. It’s hard to refute that US equities are good assets. But are they available at a good price?
As Aswath Damodaran notes, the equity risk premium on US equities has fallen to 4.3%, near historical lows, meaning investors are paying higher valuations for lower future returns. Beyond the demanding valuation, there are other risks that could challenge the performance of the world’s most adored firms. Amongst other things, key risks include the Federal Reserve’s uncertain trajectory. While rate cuts are expected, persistent inflation or geopolitical shocks could delay further easing of interest rates. Add to this market concentration risk. The Magnificent Seven now account for a disproportionate share of market gains, making indices increasingly fragile. Then there are geopolitical flashpoints. US-China tensions, instability in the Middle East, and European economic fragility pose underappreciated risks. Any expectation of market rallies on resolution of the current conflicts is unlikely to materialise – these conflicts hardly caused a blip in markets when they started, and investors have simply looked through them. If anything, resolution is already fully discounted. However, a major escalation could introduce new risk factors that markets are not yet pricing in. And then there’s Trump.
A historical perspective reinforces caution. Previous periods of prolonged outperformance underpinned by the belief that things will endure – such as the late 1990s tech boom, or emergingmarket euphoria and the long wave of commodities of the early 2000s – even eventually ended in mean reversion (by which we mean tears). It might be that investors would do well to ensure they are not over-exposed to US equities at precisely the wrong time. But that’s a hard argument to make, because we only have foresight. And it is imperfect.
China’s Economic Malaise: A Japanese Replay?
"History doesn't repeat itself, but it often rhymes."
– Mark Twain
Other things to consider as we head into 2025 are structural risks that have remained quite well hidden, but that might come to light as geopolitical risks turn into reality. Amongst other things to consider, Monetary economist Scott Sumner argues that China is following Japan’s mistakes of the 1990s, pursuing policies that are deflationary rather than stimulative. Beijing’s reluctance to allow the yuan to depreciate is preventing necessary monetary easing. Also, investor expectations of China as the global growth engine were premised on the Chinese consumer stepping in when global growth waned – this didn’t happen and is unlikely to happen. Each time Chinese policy makers stimulate the economy the reaction is that savings rates just increased in China instead. What is more, authorities face the challenge of stimulating their economy without letting the currency devalue – something they seem unwilling to contemplate.
And this creates key risks for global investors, that include weaker domestic demand which will constrain China’s contribution to global growth; capital flight risks that are growing as investors seek safer alternatives; and a slowing real estate sector that could trigger broader credit risks. The last-mentioned risk is one that has Chinese policy makers particularly anxious. Their most recent effort in priming the policy pump came in September 2024 with a comprehensive stimulus package estimated at approximately 7.5 trillion yuan (US$1.07 trillion). The policy initiative aimed to reverse the prolonged property market slump, weak consumer confidence, and slowing growth. The immediate market response saw the MSCI China and MSCI China A indices gain 21.6% and 26.1%, respectively, in the space of a week. These gains have since largely reversed, and Chinese equity markets are just about back where they started.
For a decade or more, China was seen as the engine of global economic expansion. That assumption can no longer be taken for granted. All of that said, Chinese equities sit on a cyclically-adjusted price-earnings (CAPE) multiple of 14.1 times versus the S&P 500 priced on a CAPE of 37.0. What are the chances I could convince you to flip your US equity investment into Chinese equities? Or switch Nvidia priced at 58 times earnings and 54 times net asset value into a Chinese competitor? Alibaba is priced on 12 times earnings and 1.5 times net asset value; and Baidu Inc. trades at 11 times earnings and 0.8 times book value.
Sovereign Debt Risks: The Cost of Borrowing
"We can ignore reality, but we cannot ignore the consequences of ignoring reality."
– Ayn Rand
Accepting the price of setting myself up to be wrong (the foresight thing just doesn’t go away) it is worth highlighting one of the biggest elephants in the room, namely structural risks in global bond markets. This has risks that lurk just beneath the surface for all asset classes – and it is worth highlighting the two loved asset classes of private equity and private credit.
Debt-laden governments have become increasingly dependent on artificially low interest rates that have prevailed since the global financial crisis. But rather than using low interest rates to repair balances sheets and get their fiscal houses in order, governments around the world have binged on cheap debt. After tolerating ever-rising levels of government debt, the bond market has eventually spoken, and its message is clear: higher yields are here to stay. The US Treasury market – the global benchmark for borrowing costs – has reset sharply higher, dragging bond yields up across the world. The 10-year US Treasury yield has pushed to levels last seen just before the financial crisis of 2008/09, as investors recalibrate expectations around inflation, fiscal policy, and central bank intervention.
Source: Bloomberg (2025)
While the Federal Reserve’s shift toward cutting interest rates was expected to buoy bonds, the opposite has occurred. The resilience of the US economy, persistent inflation, and surging fiscal deficits have overridden monetary policy, forcing bond yields higher despite the rate cuts of last year. This phenomenon – where long-term bond yields rise even as central banks cut interest rates – is a rare and ominous signal, historically preceding market volatility and economic slowdowns. Slowdowns and recessions are bad for earnings – and earnings shocks or bad surprises generally hurt the most when valuations are at extremes. Here, US equities are Exhibit A.
But this is not just a US story. From the UK to Japan, bond markets are experiencing their own reckoning, with investors demanding higher yields to compensate for rising risks. The UK gilt market recently saw its worst selloff since the Truss-era crisis, French debt has come under pressure amid fiscal concerns, and Japan is grappling with the unwinding of decades-long yield curve control policies. And at the time of writing, the Bank of Japan has raised its key interest rate to 0.5%, the highest level in 17 years, as Governor Kazuo Ueda continues his mission to normalise monetary policy. Bloomberg Economics is forecasting two more hikes in April and July. Yields on ten-year Japanese government bonds are at just 1.0%, and that threatens yield inversion – a hint that Japan could be facing an extension of its entrenched economic slowdown whilst inflationary risks are rising. Japanese government debt sits at 263% of gross domestic product – that’s about three times the level that is conventionally considered prudent. Here, it is also worth keeping in mind that governments have a vested interest in allowing inflation to rise – because inflation erodes the real value of debt. While central banks talk about controlling inflation, many fiscal authorities tacitly accept higher inflation as a mechanism to manage their growing debt burdens.
Crucially, the return of bond vigilantes – investors who sell government bonds to protest fiscal mismanagement – suggests that markets are no longer willing to tolerate reckless borrowing. The US debt-to-GDP ratio is projected to hit 132% by 2034, while global debt levels remain at historic highs. Factors including de-globalisation, an aging population, political volatility and the need to spend money fighting climate change are likely to add fuel to the bond fire. For Bank of America, US bonds are already well into the latest “Great Bond Bear Market,” the third in 240 years after a decades-long bull run that ended in 2020, when rates touched an all-time low during the start of Covid lockdowns.
Source: BofA Global Research (2025)
Notably, most of the recent bond market corrections have been in response to policy decisions – primarily fiscal rather than monetary. Investors often focus on interest rate changes, but the real driver of bond yields has been unsustainable fiscal positions and shifting expectations around long-term government debt. This puts a focus on quality – favouring creditors over debtors and avoiding fiscally fragile economies. Also, bond allocations must be reassessed as the era of artificially low yields is decisively over. This also suggests a shift toward real assets – commodities, infrastructure, and inflation-protected securities – as hedges against rising yields. Notably, gold did even better in 2024 than widely loved large-cap US equities, returning 26.9% as treasuries lost some more of their allure as a safe haven, while gold has flourished as emerging market central banks and Asian households in particular duck for cover in “quality money”. Perhaps there is more to come from gold if the vigilantes have their way?
Evidently, the bond market is no longer a passive participant in global finance – via the vigilantes it has reclaimed its role as the final enforcer of fiscal discipline. The only question now is how governments and central banks will respond. For us to change our investment stance we need to see proof of work and fiscal discipline rather than governments’ offering words of hope that fall on barren ground.
Principles for 2025 and Beyond
“Knowledge is more a matter of learning than of the exercise of absolute judgment. Learning requires time, and in time the situation dealt with, as well as the learner, undergoes change.”
– Frank Knight
Now that we know everything about what we don’t know, how do we respond? Unfortunately, there are some things that are constant and permanent: risk and uncertainty. But knowing that the investment future is filled with these two constants equips us to build portfolios that are positioned with that knowledge. Then, by buying at the right price, our good assets become good investments.
Borrowing from the wisdom of others, drawing from history, and learning from our own experience in markets, successful investors have at the core of their investment process a common set of timeless principles.
Diversify globally. US equities have led, but opportunities exist across emerging and developed markets. And rebalance with discipline. Periodically trimming gains and adding to laggards ensures long-term efficiency.
Focus on valuation. Price is what you pay, value is what you get. Expensive stocks often deliver lower returns, while undervalued assets create long-term opportunities. Cliff Asness’ arguments above make this point.
Prioritise quality. Bad assets at a good price are not an investment, they are a gamble. To borrow from Warren Buffett: “When a manager with a good reputation meets an industry with a bad reputation. It is normally the industry that leaves with its reputation intact.” Companies with strong earnings, high returns on equity, and solid balance sheets tend to outperform. The same goes for bonds and currencies backed by sound governments and stable central banks.
Understand risk. Volatility is not the true risk – rather, true risk is permanent capital loss. If the price of a good asset falls, it will recover in time. However, when assets go bad, the loss is permanent. And it is always worth keeping in mind that good assets go bad. Today’s darlings might become tomorrow’s fallen angels. Remember Nokia, Kodak, Xerox, real estate in 2009, WeWork, FTX, Williams F1, and perhaps FC Barcelona post Messi (with an ask for forgiveness from fans). In this vein, be wary of consensus trades. What is popular today – the Magnificent Seven, private equity, crypto, and private credit – may be overpriced. And ignore the noise. Daily headlines do not determine long-term returns. Be sure to distinguish new from noise.
Think long-term. Investing is a multi-decade endeavour, not a short-term speculation. In positioning investments, it serves us to think about 2035, rather than 35 minutes past 8pm. Avoid market timing. Stay invested. Compounding is the single-most powerful investment driver. And there is only one way that compounding can happen, and that is with time. This principle is universal. The cost of missing the best market days is greater than the benefit of avoiding the worst. We accept that volatility is part of the equation – although our endeavour is to always get the greatest return for the lowest possible volatility.
A Forecast Worth Making
“I have been increasingly moved to wonder whether my job is a job or a racket, whether economists … may not be in the position that Cicero, citing Cato, ascribed to the augurs of Rome that they should cover their faces or burst into laughter when they met on the street.”
– Frank Knight
The only reliable forecast is that investments grounded in discipline, valuation, and principles will outperform speculation and market fads. As we go into 2025, we believe that time spent predicting is a bad investment, and that time spent preparing is a wise investment – because that is the only strategy that will always hold true. In this we are alive to the illusion of certainty. Investors often make dangerous assumptions about the future, believing they can navigate markets with precision. Yet, history teaches us that investing is not about guessing correctly – it is about ensuring resilience when the unexpected happens. Because it will happen. And we are prepared.