If the Fed can't get it right, why do investors always fall for the folly of forecasting?

if the fed can't get it right, why do investors always fall for the folly of forecasting?

Three Federal Reserve chairs made incorrect forecasts on three significant events that ended up roiling global markets and economies: Alan Greenspan on the dotcom bubble; Ben Bernanke on the U.S. housing bubble and Jerome Powell on inflation.

By Noah Solomon

“Losing an illusion makes one wiser than finding a truth,” according to satirist Karl Ludwig Borne.

I have become completely disavowed of the illusion that people are able to predict the future with any degree of accuracy or consistency, and that investors can improve their results by forecasting, or by following the forecasts of others.

Not even the almighty United States Federal Reserve, with its vast resources, near limitless access to data and armies of economists, has been particularly successful in its forecasting endeavours.

For example, near the height of the dotcom bubble in 1999, Fed chair Alan Greenspan argued that the internet was bringing a new paradigm of permanently higher productivity, thereby justifying lofty stock price valuations and encouraging investors to push prices up even further to unsustainable levels.

In 2006, Fed chair Ben Bernanke brushed off the most pronounced housing bubble in U.S. history, stating that “U.S. house prices merely reflect a strong U.S. economy.”

And in late 2021, the Fed determined the spike in inflation was “transitory.” It neglected to combat it, leaving itself in a position where it had no choice but to subsequently ratchet up rates at the fastest pace in 40 years and risk throwing the U.S. (and perhaps the global) economy into recession.

Inflation was ‘transitory’

The near infinite number of factors that influence economies and markets make it nearly impossible to convert them into useful forecasts. Further complicating matters is that economies and markets are non-stationary. They are constantly evolving. The things that influence markets change over time, and so do their relative importance. To produce accurate forecasts, economists need to hit an incredibly small target, and one that is constantly moving.

This problem is well summarized by former General Electric Co. executive Ian Wilson, who stated, “No amount of sophistication is going to change the fact that all your knowledge is about the past and all your decisions are about the future.”

It’s hard enough to be right on any single prediction when it comes to economies and markets. A forecaster who gets it right 70 per cent of the time would be a rare (and perhaps even a freakish) specimen. But investment theses are rarely predicated on a single prediction.

A forecaster predicting that inflation will remain stubbornly high, rates will rise further and that these two developments will cause stocks to fall is technically making three separate predictions. Even with a 70-per-cent chance of being right on each of these forecasts, their overall prediction about the market has only a 70-per-cent chance of a 70-per-cent chance of a 70-per-cent chance of being right, which is only 34.3 per cent.

And let’s be real here, I am being generous with handicapping the accuracy of any forecaster at 70 per cent. At 60 per cent, the chances of being right on their market call falls to a paltry 21.6 per cent. Fortunately, beleaguered prognosticators get saved by the forces of randomness, which default to 50/50.

Psychology, emotion drive markets

Economies and markets are ultimately driven by the decisions of people. These decisions are heavily influenced by psychology and emotions, which by definition are difficult to model or predict. Nobel Prize winning physicist Richard Feynman epitomized the difficulties of predicting human behaviour when he said, “Imagine how much harder physics would be if electrons had feelings.”

If you wanted to predict future bear markets, then it would be logical to study previous bear markets and analyze their contributing factors. In theory, this type of analysis would enable you to identify the conditions that preceded and/or accompanied historical bear markets, thereby enabling you to flag similar conditions when they appear and avoid large losses.

Unfortunately, modern economies and markets haven’t been around long enough for anyone to draw any assertions that shouldn’t be taken with a generous helping of salt. In the postwar era, the U.S. has only experienced 13 recessions. There are simply not enough observation points. To use statistical parlance, this makes for an exceedingly large “error term.”

Further compounding the problem is that no two bear markets have been or are likely to be the same in terms of their respective causes and characteristics.

Most people would assess the manager’s record when contemplating investing with them. Paradoxically, these very same people are perfectly willing to listen to (and perhaps act upon) the advice of economists and strategists without any indication of how successful their historical forecasts have been. I am not aware of any study that has ever quantified the investment results that could have been achieved by following the recommendations of any single forecaster or group of forecasters.

I’m not saying the emperor has no clothes. Rather, I am merely stating that we have no way of knowing whether they do or don’t. And yet there is no shortage of professional forecasters. There is also no dearth of investors willing to pay for their purported wisdom and prescience.

I am not implying that forecasts can never be right. I am merely saying they can’t be right often enough to be valuable. This begs an obvious question: Why do investors keep listening to or acting on predictions?

Perhaps the best explanation is that certainty is so valuable that investors will never give up the quest for it. If you could predict markets with a high degree of accuracy, your results would put even Warren Buffett to shame. In the words of ancient Greek philosopher Demosthenes, “Nothing is easier than self-deceit. For what every man wishes that he also believes to be true.”

Rather than trying to divine a future that is simply not knowable, the objective should be to invest as wisely and as prudently as possible in the absence of that knowledge. Or, as American journalist and scholar Henry Lewis Mencken said:  “We are here and it is now. Further than that, all human knowledge is moonshine.”

Of course, systematic processes based on data analysis and machine learning have a clear advantage over their “human” counterparts when making investment decisions based on existing (rather than forecasted) conditions.

The jury has ruled: a multitude of academic research spanning more than half a century overwhelmingly demonstrates that rules-based models outperform discretionary decision-making by human experts.

Noah Solomon is chief investment officer at Outcome Metric Asset Management LP.

_____________________________________________________________

If you like this story, sign up for the FP Investor Newsletter.

_____________________________________________________________

News Related

OTHER NEWS

Ukraine's Zelenskiy visits flood-hit area after Kakhovka dam collapse

A view shows flooded residential buildings after the Nova Kakhovka dam breached, in Kherson KYIV (Reuters) – Ukrainian President Volodymyr Zelenskiy visited the flooded southern region of Kherson on Thursday ... Read more »

Sabrina Maddeaux: Ontario Liberals would do well to avoid 'Queen NIMBY' becoming party leader

Mississauga Mayor Bonnie Crombie attends a news conference at the Ontario legislature in Toronto on May 18, 2023. Sabrina Maddeaux writes that Crombie is exacerbating Ontario’s housing crisis by opposing ... Read more »

Man Utd: Jordan makes huge Kane transfer prediction after his ‘conversation’ with Spurs chief Levy

Tottenham striker Harry Kane Simon Jordan has revealed that he has had a “conversation” with Daniel Levy and this has made him think Man Utd target Harry Kane will stay ... Read more »

Prince William voted most popular UK royal, ahead of wife Kate, Charles and Camilla

Prince William has been voted the most popular UK royal, beating his wife Kate, Princess of Wales, and his father King Charles III to the top position. However, he remained ... Read more »

Vikings Are Reportedly Fielding Calls For Pro Bowler On Wednesday

Vikings Are Reportedly Fielding Calls For Pro Bowler On Wednesday The Minnesota Vikings are reportedly fielding calls regarding to availability of three-time Pro-Bowl pass rusher Danielle Hunter, according to NFL Network ... Read more »

Brace for severe air quality issues Thursday, then a slow improvement on Friday

Visit The Weather Network’s wildfire hub to keep up with the latest on the active start to wildfire season across Canada. With surface smoke travelling south this week, poor air ... Read more »

Tensions simmer in House GOP as party leaders squabble over hardliners’ demands

A conservative revolt paralyzing the House has set off a bitter blame game among the upper ranks of GOP leadership, with top Republicans scrambling to defuse internal tensions that have ... Read more »

Ohio congressional delegates make pitch for Space Command headquarters

Ohio congressional delegates make pitch for Space Command headquarters Members of Ohio’s congressional delegation made a pitch for the U.S. Space Command (Spacecom) to be relocated to the state amid ... Read more »

Android 14 Beta 3 is now rolling out

Android 14 Beta 3 is now rolling out Google’s Android 14 Beta 3 is now available. Beta 3 marks the Platform Stability stage, where developers can finalize final details ahead ... Read more »

The Best Father’s Day Gifts Hiding In Plain Sight On Amazon

Not to brag, but we’ve become pretty savvy when it comes to gifting. Having a front seat as shopping editors tends to have that effect, after all. However, we’ll admit ... Read more »

Oil weakens on demand concerns as focus turns to Fed

FILE PHOTO: Pump jacks operate at sunset in an oil field in Midland By Alex Lawler LONDON (Reuters) – Oil fell on Thursday as worries about weakening demand in a ... Read more »

A Los Angeles house that's badly in need of repairs and sits over a public bridge is on the market for $250,000. The agent said more than 40 groups showed up for an open house.

When viewed from the side, the house looks like it sits over the bridge because of the concrete archway underneath it. Compass Real Estate An LA apartment that sits over ... Read more »

Biden to host thousands at White House Pride party

U.S. President Joe Biden and LGBTQ advocate Ashton Mota of the GenderCool Project walk before delivering remarks to commemorate LGBTQ+ Pride Month in the White House, Washington, U.S., June 25, ... Read more »

A super-rare "Perigee Blue Moon" lights up the night sky this summer

With warm nights during the summer months, this is just about the best time of year to stay up late and gaze up into the heavens. Watch for some of ... Read more »

Half the world's biggest companies are downsizing office space amid hybrid working

An empty office. Thomas Barwick/Getty Images A Knight Frank survey of 350 companies found half of large companies plan to downsize office space. That’s been sparked by a move towards ... Read more »

Ukraine's Zelensky visits flood-hit area after Kakhovka dam collapse

A satellite image shows the Nova Kakhovka Dam and hydroelectric plant before its collapse, in Nova Kakhovka, Ukraine June 5, 2023 Ukrainian President Volodymyr Zelensky visited the flooded southern region ... Read more »

You Can Fly to This Quaint Caribbean Island for Under $200 Thanks to This New Jet Blue Route

And tickets are on sale now. Nellmac/Getty Images JetBlue is continuing to add warm-weather destination flights to its roster — it’s latest addition? The Caribbean island of St. Kitts. Travelers ... Read more »

BC Pharmacists Can Now Deal with Basic Ailments and Contraception

British Columbians suffering from pink eye, shingles, a urinary-tract infection, hemorrhoids or in need of contraception can now head to their local pharmacy rather than a doctor’s office to get ... Read more »

Delta Opens New Delta One Check-In at LAX

Delta One Check-In at LAX Delta and Los Angeles International Airport (LAX) have wrapped-up another phase in the Delta Sky Way at LAX project with the completion of a new ... Read more »

CITY ISSUES: The latest from some of Toronto’s top mayoral candidates

Josh Matlow, left, applauds a comment from Mitzie Hunter, centre left, as they are joined on stage by Olivia Chow, second left, Brad Bradford, centre right, Mark Saunders, second right, ... Read more »

Calgary Flames prospect Cade Littler has swapped college commitments

Calgary Flames prospect Cade Littler has swapped college commitments In the seventh round of the 2022 NHL Draft, the Calgary Flames selected centre Cade Littler of the BCHL’s Wenatchee Wild. ... Read more »

Hands-on with the new 15-inch MacBook Air

Hands-on with the new 15-inch MacBook Air Apple just announced the new MacBook Air 15, a 15-inch version of the most popular laptop in the world. I just saw it ... Read more »

Cowboy country in British Columbia: a taste of pioneer days with a ranch stay

In British Columbia, the area around the Cariboo Chilcotin Coast is home to large numbers of guest ranches such as Echo Valley, where wrangler Mike Christensen leads horse experiences between ... Read more »

Louisiana Senate passes bill banning gender-affirming car for transgender youths

Louisiana Senate passes bill banning gender-affirming car for transgender youths BATON ROUGE, La. (AP) — A controversial bill — that at one point had been presumed dead — banning gender-affirming ... Read more »

Ukrainian offensive is ‘taking place in several directions,’ says official

A Ukrainian offensive is “taking place in several directions,” Deputy Defense Minister Hanna Maliar told Ukrainian television on Monday, as speculation mounted that Kyiv would soon launch a summer counteroffensive ... Read more »

New teams emerge as potential buyers for DeAndre Hopkins

DeAndre Hopkins As teams around the league begin minicamp, the DeAndre Hopkins free agency watch continues. The list of potential suitors for the veteran wideout has fluctuated in recent days, ... Read more »

'It was tough': World War II veterans return to Utah Beach to mark D-Day's 79th anniversary

‘It was tough’: World War II veterans return to Utah Beach to mark D-Day’s 79th anniversary ON UTAH BEACH, France (AP) — World War II veterans shared vivid memories of ... Read more »

Hovland goes from winning Memorial to caddying in US Open qualifier

COLUMBUS, Ohio (AP) — Viktor Hovland didn’t have much time to celebrate the biggest win of his career. One day after winning the Memorial, he went 36 holes as a ... Read more »

Apple announces new VR headset Vision Pro, to launch next year

“It’s the first Apple product you look through, not at,” Apple CEO Tim Cook said while introducing the Apple Vision Pro, the company’s new virtual reality headset that will allow users ... Read more »

Northeast wildfire now the third largest in B.C's history: BC Wildfire Service

The BC Wildfire Service says the Donnie Creek wildfire has grown into one of the largest blazes over the last century in the province. The fire, which is burning north ... Read more »
Kênh kiến thức kỹ năng, phát triển bản thân, hướng nghiệp, blog nhân sự