The Follies of Fortune Telling

I grew up watching “60 Minutes” Sunday evenings, so like many people, I was saddened to hear of the death of commentator Andy Rooney last month. He was occasionally too curmudgeonly even for me, but he presided over the final minutes of a show that was a fixture in our household. One of my favorite segments aired a few years ago, when Rooney replayed bits from a 1986 CBS News series that previewed what life would be like in 2001. Experts predicted that the Russians would land on Mars, cars will be commanded by operator's voice, Americans would work just 30 hours a week, cows would be the size of elephants, and pigs would be five feet tall.

It hasn't quite turned out that way. Cows and pigs are still the size of cows and pigs, and my car doesn't respond to my voice — not even the expletives I shout in traffic. It's important at this time of year to remember how hard it is to predict the future, because soon we'll begin to see articles in media featuring various experts' guesses for what the stock market will do in 2012.

As evidence of the value of such forecasts, let's travel back to a Jan. 2, 2002 article in USA Today. The article featured the predictions of eight top Wall Street analysts and where they thought the S&P 500 would be at the end of 2002. The article began by pointing out that not one of the analysts polled a year earlier were right about 2001: Each had predicted a positive year for the S&P 500. Instead, it declined 13%. Did they do a better job in 2002? Nope. The average prediction was for an 11% gain. As you may recall, the S&P 500 declined more than 22% in 2002.

More recently, a BusinessWeek article published at the end of 2007 listed the predictions of six strategists of where the Dow would be at the end of 2008. The average guess was 14,925; by Dec. 31, 2008, the Dow had plummeted to 8,776.

Some prognosticators expected the Dow to be even higher. Back in March of 2008, Mark Hulbert — who has tracked the performance of hundreds of newsletters since 1980 — highlighted the prediction of Richard Band, whose newsletter's risk-adjusted return was “in the upper echelon of newsletters.” Band claimed that the market was forming “the ‘right shoulder' of a head-and-shoulders bottom,” and the Dow would reach 16,000 by late 2008 or early 2009. Instead, the Dow closed as low as 6,547 in March 2009.

My favorite prediction from 2008 came from a Wall Street Journal article that highlighted the views of Igor Panarin, a former KGB agent and the dean of the Russian Foreign Ministry's academy for future diplomats. Since 1998, he has propagated a theory that the United States would break up into six pieces in the summer of 2010, due to “mass immigration, economic decline, and moral degradation.” According to the article:

California will form the nucleus of what he calls “The Californian Republic,” and will be part of China or under Chinese influence. Texas will be the heart of “The Texas Republic,” a cluster of states that will go to Mexico or fall under Mexican influence. Washington, D.C., and New York will be part of an “Atlantic America” that may join the European Union. Canada will grab a group of Northern states Prof. Panarin calls “The Central North American Republic.” Hawaii, he suggests, will be a protectorate of Japan or China, and Alaska will be subsumed into Russia.

Alaska will be part of Russia? Has anyone told Sarah Palin?

Why we love predictions, and why we shouldn't
In September, the Freakonomics team (author Stephen Dubner and economist Steven Levitt) devoted an entire podcast to predictions. They interviewed Phil Tetlock, a research psychologist at the University of Pennsylvania. Tetlock says, “There are a lot of psychologists who believe that there is a hard-wired human need to believe that we live in a fundamentally predictable and controllable universe. There's also a widespread belief among psychologists that people try hard to impose causal order on the world around them, even when those phenomena are random.” This creates a desire — and market — for forecasters. But how good are these soothsayers?

Over the past 20 years, Tetlock has tracked approximately 80,000 predictions of 300 political experts. The result: Their predictions are only slightly more accurate than a sample of undergraduate students or random guessing, and slightly worse than “a computer programmed to predict ‘no change in current situation.'” Not very impressive.

The Freakonomics team also interviewed Christina Fang, a Professor of Management at NYU's business school. She co-authored a study of the Wall Street Journal's Survey of Economic Forecasts, which asks 50 economists about various macroeconomic numbers. According to Fang, the study found that “those people who correctly predicted either extremely good or extremely bad outcomes, [are] likely to have overall lower level of accuracy. In other words, they're doing poorer in general.”

This is important to keep in mind, since the people who get the most air time are the ones who make the most extreme predictions. As Levitt explained, “The incentives for prediction makers are to make either cataclysmic or utopian predictions, right? Because you don't get attention if I say that what's going to happen tomorrow is exactly as what's going to happen today… I don't get on TV.”

Your prediction-protection strategy
Okay, so no one knows what the stock market will do next year or even the next few years. There is evidence to suggest that overall market valuation provides a hint as to what to expect for the next seven to 10 years. That's helpful for retirement planning, since we can use that estimate in our financial calculations. But it doesn't help the market timer.

Of course, as investors we must make some assumptions about what the future will look like, since investing is all about buying something today that you think will be worth more — both in absolute terms as well as relative to other investments — years from now. Here's how to balance the need to make bets on the future without trying to do the impossible:

  • Only pay attention to people who have a track record of being right about things that are possible to be right about. An expert stock picker or fund manager could possibly be skilled… or just lucky. Someone who correctly guesses where the Dow will be a year from now is definitely just lucky.
  • Since the stock market can drop in any given year — despite what the “experts” predict — make sure you keep money you need in the next three to five years out of the market.
  • Be aware of incentives. Is someone making a prediction that leads to buying a certain product or service she or he sells?
  • Is the person dogmatic or ideological? Tetlock's research found that people with pre-set, rigid beliefs had the worst record.
  • Invest at least a portion of your money according to the acknowledgement that you — or the advisers and managers you hire — could be wrong. In other words, stay diversified and invest at least some of your assets in index-based investments.
  • Don't run your financial life in a manner that is dependent on just one outcome or on your life continuing on the same path uninterrupted. Always have a Plan B.

I have more to say about predictions, but I must get going. As a resident of the Washington, D.C., metropolitan area, I plan on converting my dollars into euros and preparing my campaign for president of “Atlantic America.”

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Emily Hunter
Emily Hunter
8 years ago

This is great! I’ve found that one of the aggravating things about predictions is that some of them are self fulfilling types of prophecies – you tell folks that the world’s going to hell, and they have just enough wherewithal to make it happen. But I tell you what, some of the predictions of watching the money markets are fun. 🙂

getagrip
getagrip
8 years ago

I think this has gotten worse and worse as technology has gotten faster and more widespread. Now there is a desire for knowledge instantly at your fingertips, constant updates and tracking, and an often insane reliance on minutia all fueled by being constantly wired in and buffeted by the information flow. Right or wrong those who scream the loudest in the din catch your attention. It’s hard to sift through the noise to see what’s important.

Beth
Beth
8 years ago
Reply to  getagrip

It drives me crazy when a company makes an announcement and their stocks rise or fall dramatically based on a single story.

Unfortunately, financial news is like any other kind of news — it drives revenue for the publisher.

Nancy L.
Nancy L.
8 years ago
Reply to  Beth

The really stupid thing is that most industry “insiders” (read: involved enough to know the players but not true insider trading) usually have a sense long before official announcements come down the pike, and make their trades well before the day of the announcements. A really good example of this is Apple announcing new products. By the time Apple gives a keynote address, the rumor mill generally has about 75-90% of what is going to be announced nailed down, and serious investors have already positioned themselves accordingly. If you wait until the day of the announcement to buy or sell,… Read more »

Beth
Beth
8 years ago

I think I needed this reality check, thank you! I’ve been trying to figure out my goals for 2012 and not knowing where to invest or whether to buy a condo while interest rates are low is very much on my mind. (Housing prices keep going up in my area, but I don’t know how long that’s going to last!) This is a good reminder that you have to plan according to what you live with. (For instance, could I afford to lose money in the market? What would happen if my home loses value?) I’d rather hope for the… Read more »

Nancy L.
Nancy L.
8 years ago

The problem with most economic forecasting models is that they start with numbers, whereas the actual economy is often more driven by emotions. As someone not trained in business models, but trained in observation of human reactions, I find that I usually have a better sense of what’s likely to happen than most formal “predictions”, simply bc I’m pretty good at predicting what the public reaction will be. Of course, I also realize that since so much is based on intangibles that can be hard to foresee, I would not try to invest serious money on even my predictions. I… Read more »

Carrie Hetu
Carrie Hetu
8 years ago

Great Article, I think many would forget the tip about keeping money out of the stock market that you may need from now to near future. Predictions are simply that, predictions and to me I take them with a grain of salt but read with keen interest 🙂

AverageJoe
AverageJoe
8 years ago

Wonderful article. I am constantly amazed at the number of people that love to guess where the market is headed AND make big financial bets on the direction.

I’m nearly as amazed at the number of people who refuse to play any defense with their portfolio at all.

Your piece is definitely a call for defense. Not because things are bad, but simply because we never know what’s going to happen next.

Tyler Karaszewski
Tyler Karaszewski
8 years ago

But the market returns 8% after adjusting for inflation every year! I used that number in all my examples! How else can I tell people that buying an iPhone coats half a million dollars? Now you’re saying that I can’t just assume 8%? How will I know when I’ll be able to tell people in the Internet that I’m “financially independent” then?

Elizabeth
Elizabeth
8 years ago

Too funny!

I find it really hard to figure out when I’ll reach “financial independence” because right now the numbers are so gloomy. It doesn’t help to tell me that the market yields 8% per year when my early years aren’t looking so hot. Is the market supposed to drastically jump to compensate?

MC
MC
8 years ago
Reply to  Elizabeth

No that means everything is on Sale! Hurry, buy now!

Crystal Stemberger
Crystal Stemberger
8 years ago

Good tips! I also try to ignore the prediction makers, invest in solid companies, and just keep an eye on things. No one can actually predict the future…even if they could, it’s not like they’d share that info with you…

Bareheadedwoman
Bareheadedwoman
8 years ago

These are only the predictors on mainstream media. There are plenty of fringe financial gurus who predicted both the gradual market decline through the first few years of the century and culminated with predicting a crash in 2008-9; self same guru’s predicted the rising price of gold and silver etc etc…depends on whom you listen.

But people do tend to want to believe good news over bad.

I was an early reader of Motley and the Daily Reckoning…I remember well the musings of what would happen in an America that thought it “got paid to think”.

Jackowick
Jackowick
8 years ago

I enjoy predictions when people are selling books or advertising, or are just looking for an excuse to not take control of their life if “A, B, and C are going to happen and screw us all, so I’m going to buy a new TV before the financial apocalypse”. Also, conspiracy nuts love predictions as evidence that they are “right”. Again, motivation is the nugget to dig down to. And tying this again to conspiracy nuts, the world is far more boring than speculators and entertainment fiction. It’s pretty rare that a plane crashes into a building, and just because… Read more »

babysteps
babysteps
8 years ago

I used to work on Wall Street and interact with the economics staff of our brokerage. They were very proud of their 40-variable model that had been backward tested and ‘proven’ accurate. Mathematically, if you have 40 variables and are allowed to give them cyclical direction (eg you assume that they will go up or down in the future, based on a given usual length of cycle in the past) you can match *anything* with a backtest. I don’t remember the exact math, but functionally it only takes about 4 variables to build a ‘really good model’ if you’re allowed… Read more »

Jasanna
Jasanna
8 years ago

This is so true. As I learned in my Microecon class this semester…nobody TRULY knows where the stock market will go. They may sure think they do, and even be right sometimes, but they truly do not know…

jim
jim
8 years ago

That stuff from the Russian guy predicting the USA would split up into 6 parts is hilarious. Its clear he doesn’t know anything about Texas.

Sara
Sara
8 years ago
Reply to  jim

“Alaska will be part of Russia? Has anyone told Sarah Palin?”

Perhaps that’s how she saw Russia from her backyard? 😉 (Yes, I know that was Tina Fey.)

whoisbiggles
whoisbiggles
8 years ago

Keep an eye out for “The Economists” oops we were wrong section in their Year in review magazine issue.

Got to respect people who are willing to ‘fess up when they get their predictions wrong.

Dan
Dan
8 years ago

Yeah I like this, prediction isn’t a physical thing in a sense. They can call themselves experts and praise that they hold all the answers, but in the end it is only us that can really determine our own fates.

The paths that we go down whether experiencing successes or failures are 99% determined by the individual, and them alone.

Christa
Christa
8 years ago

So, how big were elephants supposed to get?

It’s amazing how incorrect a lot of predictions are. I agree that we should take predictions with a grain of salt and listen to those who are often correct.

JEB
JEB
8 years ago

Great piece and perfect timing. The talking heads on TV and their obnoxious cousins of talk radio really irk me when it comes to the extremes of predictions. Glad to hear a much more reasonable take on things. Now, just for the sake of saying: The ‘experts’ from 1986 were a little off on the timing, but thanks to blue-tooth and other technologies you have been able to control your car (at least parts of it) with your voice since about 2004. These systems seem to be improved and expanded each year. Yep, we will soon be flying our boy… Read more »

Andre
Andre
8 years ago

This is basically the point Nasim Taleb makes in his book “Black Swan”: No one can predict the future. It’s a fascinating read how he took that unpredictability into an investment strategy.

For those of you who is going to say “but look at XYZ!”… the problem with predictions is that failures are never publicized, yet when it’s successful, these predictors trumpet it – thus creating a bias.

Imagine flipping a coin and being able to hide 50% of your flips… suddenly you’re a soothsayer.

Jackowick
Jackowick
8 years ago
Reply to  Andre

The Black Swan is great, but too many laypeople (and finance professionals) took it as a reason to believe more in the outlier than in the fat meaty middle of the bell curve. If everyone bets on the underdog winning the superbowl, Vegas adjusts the odds. Same thing with Wall Street if everyone is going nuts. I’m not going to pontificate on my own thoughts on gold, but ever notice that when something becomes a super hot “sure thing”, there’s a correction bubble at some point? If everyone is betting A, you go B to be a Black Swan. The… Read more »

Raya from Bulgaria
Raya from Bulgaria
8 years ago

Great post! I’ve always been against long-term planning and long-term forecasting EXACTLY BECAUSE things are so complex no one can say for sure what’s going to happen. Just look at how your average day goes. Unexpected stuff happens all the time: your bus is late, there’s an emergency at your kid’s school, or maybe you’re stuck in an elevator and that somehow changes your whole day. If you can’t predict how tomorrow goes, what can we say about a year or years from now? Just see a couple of old sci-fi movies like “2001: A Space Odyssey”. Yeah right! 🙂… Read more »

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