This week, a famous fund manager declared a 50% probability of a world war. The market gained despite the doomsday prediction and reports of rising inflation.
Why is the market rising when there are two brutal wars and the possibility of a world war that could wipe out humanity?
The answer is simple in a way, and the rationale for investors goes as follows:
If a world war occurs, nothing will be left. There is no point in selling for cash or even buying gold. But if a world war does not happen, the long-term uptrend in stocks will resume. Therefore, the best action is to add to positions.
This rationale is due to Bayesian updating: wars erupt, but the end of the world of the doomsday prophets has not occurred yet. There is no point in selling stocks while the indexes are still in a drawdown. It is better to add to positions because if the war never happens, stocks will go up. Even if they go down due to fundamentals, many investors plan to martingale (average down) because they know this is a long-term winning strategy.
Therefore, I am always skeptical of doomsday predictions with retail investors as the target. Probably many are influenced and sell in panic. But the truth is that a world war has a very low probability, except in the case of an accident or deliberate action outside of the context of game theory equilibrium. Panic selling creates opportunities for large funds due to a rise in liquidity. They can buy large numbers of shares without moving the market against them.
I am not alluding to the possibility that doomsday predictions are part of a broader investment strategy. They may be due to legitimate concerns. But they should not drive investment decisions.
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