Distrust Forecasts

Photo Credit: New America || Could only drive through the rear-view mirror

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This is the time of year where lots of stray forecasts get given.  I got tired enough of it, that I had to turn off my favorite radio station, Bloomberg Radio, after hearing too many of them.  I recommend that you ignore forecasts, and even the average of them.  I’ll give you some reasons why:

  • Most forecasters don’t have a good method for generating their forecasts.  Most of them represent the present plus their long-term bullishness or bearishness.  They might be right in the long-run.  The long-run is easier to forecast, in my opinion, because a lot of noise cancels out.
  • Most forecasters have no serious money on the line regarding what they are forecasting.  Aside from loss of reputation, there is no real loss to being wrong.  Even the reputational loss issue is a weak one, because Wall Street generally has no memory.  Why?  Enough things get predicted that pundits can point to something that they got right, at least in some years.  Memories are short on Wall Street, anyway.
  • The few big players that make public forecasts have already bought in to their theses, and only have limited power to continue buying their ideas, particularly if they are wrong.  This is particularly true in hedge funds, and leveraged financial firms.
  • Forecasts are bad at turning points, and average forecasts by nature abhor turning points.  That’s when you would need a forecast the most, when conditions are going to change.  If a forecast presumes “sunny weather” on an ordinary basis it’s not much of a forecast.
  • Most forecasters only think about income statements.  Most of the limits stem from balance sheets proving insufficient, or cash flows inverting, and staying that way for a while.
  • Most forecasts also presume good responses from policymakers, and even when they are right, they tend to be slow.
  • Forecasts almost always presume stability of external systems that the system that holds the forecasted variable is only a part of.  Not that anyone is going to forecast a war between major powers (at present), or a cataclysm greater than the influenza epidemic of 1918 (1-2% of people die), but are users of a forecast going to wholeheartedly believe it, such that if a significant disaster does strike, they are totally bereft?  When is the last time we had a trade war or a payments crisis?  Globalization and the greater division of labor is wonderful, but what happens if it goes backward, or a major nation like France faces a scenario like the PIIGS did?

I leave aside the “surprises”-type documents, which are an interesting parlor game, but have their own excuses built-in.

My advice for you is simple.  Be ready for both bad and good times.  You can’t tell what is going to happen.  Valuations are stretched but not nuts, which justifies a neutral risk posture.  Keep dry powder for adverse situations.

And, from David at the Aleph Blog, have a happy 2017.


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