“We have two classes of forecasters: Those who don’t know and those who don’t know they don’t know.” – John Galbraith, Economist
When will the next recession hit? Where are interest rates headed? Which stock will perform best over the next few years?
Americans pay millions every year to financial advisors, economists, and other pundits for answers to these questions, and unfortunately, many financial service professionals claim to know the answers. But is there credible data suggesting anyone can reliably forecast outcomes? Will implementing advice based on an “expert’s” forecast or prediction help you gain an advantage?
Warren Buffett said it best: “Forecasts may tell you a great deal about the forecasters; they tell you nothing about the future.”
A 2017 joint-research effort between Harvard, Oxford, and Brown Universities suggested (not for the first time) ignoring everything so-called “experts” predict could actually produce superior investment results.
The research found that over the last 35 years, U.S. company stocks seen as sure winners by analysts on average performed much worse than the stocks analysts predicted to flop.1
In fact, from 1981 to 2016, the research found the top 10 percent of stocks that analysts were most hopeful about from an earnings growth standpoint generated returns 12 percent lower on average (on an annualized basis) than the 10 percent of stocks they were most pessimistic about.1
Think about that for a second. Had you invested $100,000 in the stocks that analysts were most optimistic about over this time period, your initial investment would have turned into $281,386. Had you invested the same $100,000 in the stocks that analysts were most pessimistic about, your initial investment would have turned into $13,317,552. Stating the obvious, that’s a difference of over $13 million!
The study referenced above is far from the only available research showing trends of noticeable divergence between actual market performance and forecasts made by “gurus.”
A study performed by the CXO Advisory Group examined 6,582 individual market forecasts made by 68 well-known “gurus” from 2005-2012 and found only 46.9% of forecasts made by these gurus during the time period proved to be accurate.2
Said differently, there are better statistical odds of simply flipping a coin than placing credence in expert forecasts or predictions.
As evidenced by the research above, relying on professional judgement, news media, or any other market forecasts to predict future returns has never been a dependable strategy over any time period.
We live in a time and place where irregular and unplanned events are a certainty that can produce many different outcomes. Fiscal and monetary policy, geopolitical conflicts around the world, technological developments, natural disasters, and, in this day and age, even tweets sent out by the POTUS can alter and affect capital markets.
I’m confident neither I nor anyone else can forecast the cyclical economy, nor time the markets, nor say with certainty which stock or bond fund will outperform its peers.
It’s not always easy tuning out the noise, but there are ways to mitigate the effect of prediction and prophesy:
1. Turn off the TV
Understanding how financial news media like CNBC are incentivized is critically important. The more people tuning into their programs or clicking on their websites, the more profitable that content becomes. We are much more inclined to tune into entertaining, drama-filled content than boring, repetitive messages. If the media constantly distributed solid (but boring) investment advice like, “buy low and sell high,” or, “just buy a low-cost index fund,” fewer people would engage. Regardless whether the advice is sound or not, statements like, “expect a recession in the next 6 months,” are sure to grab your attention.
2. Have a plan
A well-crafted financial plan that was built to fund your most cherished and revered goals in life provides context and meaning to the financial decisions you make. Since there is no evidence anyone can reliably and consistently forecast what’s next, there probably isn’t a compelling reason to make changes to your portfolio unless your goals and objectives have changed.
3. Don’t try to outsmart the market
We know trying to beat the market through tactics like stock picking or market timing is a fool’s game. Instead of reacting to predictions you hear in the news or from your neighbor, have a disciplined strategy predicated on low-cost, broadly diversified investments.
An investment philosophy that requires knowledge of the future is fundamentally flawed. Beyond historically accurate facts, the rest is a guessing game played by those pretending they know something they don’t. It’s time this industry stops pretending.
Sources: 1. Pedro Bordalo, Nicola Gennaioli, Rafael La Porta, and Andrei Shleifer (2017). DIAGNOSTIC EXPECTATIONS AND STOCK RETURNS 2. CXO Advisory, 68 Market Gurus with more than 100 Forecasts for the period ending Dec. 31, 2012, http://www.cxoadvisory.com/gurus