It’s time to market forecasters to admit the errors of their ways
Washington Post, January 18, 2015
I come not to praise forecasters but to bury them.
After lo these many years of listening to their nonsense, it is time for the investing community — and indeed, the seers themselves — to admit the error of their ways. Most forecasters are barely cognizant of what happened in the past. And based on what they say and write, it is apparent (at least to this informed observer) that they often do not understand what is occurring here and now.
So there’s no reason to imagine that they have the slightest clue about the future.
Economists, market strategists and analysts alike suffer from an affinity for making big, frequently bold — and most often, wrong — pronouncements about what is to come. This has a pernicious impact on investors who allow this guesswork to infiltrate their thinking, never for the better.
I have been beating this drum for more than a decade. What say we finally put a fork in Prediction, Inc.?
There is a forecasting-industrial complex, and it is a blight on all that is good and true. The symbiotic relationship between the media and Wall Street drives a relentless parade of money-losing tomfoolery: Television and radio have 24 hours a day they must fill, and they do so mostly with empty-headed nonsense. Print has column inches to put out. Online media may be the worst of all, with an infinite maw that needs to be constantly filled with new and often meaningless content.
Just because the beast must be fed does not mean you must be dragon fodder. (More on this later.)
The other partner in this mutually beneficial dance is the financial industry. Forecasting is simply part of its marketing strategy. There are two principle approaches to meeting the media’s endless demand for unfounded guesses about the future. Let’s call them a) Mainstream and b) Outlier.
The Mainstream strategy is simple: Take the average annual change in whatever the subject at hand is and extrapolate forward a year. Voila! You have a mainstream forecast. If you are talking about equities, predict an 8 to 10 percent gain in the Standard & Poor’s 500-stock index. For economic data, project out the past 12 months forward. You can do the same for gross domestic product, unemployment, commodity prices, bonds, inflation, just about anything with a regularly changing data series. If you are feeling puckish, you can shade the numbers slightly up or down to separate your prediction ever so slightly from the rest of the pack — just to keep it interesting. As Lord Keynes once said, better to fail conventionally than succeed unconventionally.
A perfect example is the recent collapse in oil prices. Having completely missed the 50 percent drop that occurred over 2014, analysts are now tripping all over themselves to forecast $40, $30, $20 per barrel in 2015. Since their prior guesswork completely missed the biggest energy story in decades, why should any of us care about their current guesswork?
Then there is the Outlier approach, where a wildly unorthodox forecast is made. The prognosticator predicts the Dow Jones industrial average at 5,000 when it’s three times that, or hyper-inflation, or $10,000 gold, or a 1 percent yield on the 30-year treasury bond, or a collapse in the Federal Reserve’s balance sheet.
If it comes to pass, the forecaster is feted as a rock star. If not, most people forget. (Although some of us actually track these outlier forecasts). Those in the prediction industry are pernicious survivors. They understand how to play on the human psyche to great advantage. Like the cockroach, they adapt well to conditions of chaos or uncertainty.
There is a flaw in the human wetware that leads to a demand for even more (bad) predictions. The evolutionary propensity that humans suffer from is the desire for specific predictions from self-confident leaders.
This is demonstrated in a wealth of academic data about forecasting track records. Research has shown there is a high correlation between a forecaster’s appearance of self-confidence and believability. Unfortunately, there is an inverse correlation with accuracy, for reasons revealed by the Dunning and Kruger studies on metacognition and self-evaluation. Same with specificity: Studies show that the more precise a prediction, the more likely it will be believed, and the less likely it is to be right. These (and other) factors set up viewers to have the most faith in the people who are least likely to be right.
Perhaps the biggest issue of all is the most obvious: Human beings, in general, stink at predicting the future. All of you. History shows us that people are terrible about guessing what is going to happen — next week, next month, and especially next year.
In other words, expert forecasts are statistically indistinguishable from random guesses.
What should investors do instead of paying attention to these unsupported, mostly wrong, exercises in futility called forecasting? I suggest three simple things:
1) Have a well-thought financial plan that is not dependant upon correctly guessing what will happen in the future.
2) Have a broad asset allocation model that is mostly passive indexes. Rebalance once a year.
3) Reduce the useless, distracting noise in your media diet.
It is important for investors to understand what they do and don’t know. Learn to recognize that you cannot possibly know what is going to happen in the future, and any investment plan that is dependant on accurately forecasting where markets will be next year is doomed to failure.
Never forget this simple truism: Forecasting is marketing, plain and simple.
This week, the “Masters in Business” podcast features Part 2 of an interview with Bill Gross, formerly of Pimco, now with Janus Capital; Part 1 is here.
Gross sat down with me in the Bloomberg studios in New York for an extensive two-hour interview. In part II, we discuss the Allianz takeover of Pimco, why he is a tough boss to wrk for. He said he was fired by Pimco, and was blindsided by the coup.
We also talk QE and the Fed, what they did right and wrong, and what he wants to do at Janus. He also said quite a few surprising things about the Federal Reserve.
Good Saturday morning. Pour yourself a strong cup of Sumatra, settle into your favorite chair, and enjoy our longer form weekend reads: • 22 Smart Investment Ideas (Barron’s) • How stories change hearts and brains (Aeon) • Why you should stop relying on your phone, and buy a nice camera (The Verge) • The Virtue of Scientific Thinking…Read More
Category: Financial Press
Succinct Summations week ending January 23rd Positives: 1. ECB to start a QE of their own; 60 billion a month until September 2016 and markets around the world explode higher 2. Housing starts rose 4.4% in December to an annualized pace of 1.09mm coming in much stronger than the 1.2% and 1.02mm expected. 3. The…Read More
It’s Friday already! Busy week snuck by when we weren’t looking. No worries, our morning train reads are primed to go: • Relative to bonds, S&P 500 companies may be about as cheap as they’ve ever been. (Housel) • Draghi: “There must be a statute of limitations for those who say there will be inflation” LOL…Read More
Category: Financial Press
Source: Classic Driver Source: Classic Driver
Mr Draghi (Super Mario) delivered yesterday, despite the leaks which virtually gave away the details of his announcement ahead of the press conference. The EZ Central Banks (coordinated by the ECB), together with the ECB is to buy E60bn of government, ABS’s, covered bonds and agency debt, per month, commencing March 2015 up to at…Read More