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Despite a lot of rhetoric over the so called ‘September effect’ most major markets around the world ended last month at or just below 12 month highs. The ASX 200 surged almost 6% over September to finish higher for the 7th consecutive month, whereas in the US the Dow was around 2.5% firmer for the month. While the American experience sounds less impressive, it was nonetheless a positive result and marked the best quarterly performance since 1998. In both cases, US and Australian markets have climbed an astounding 50% since the bear market low in March.
For the most part, the investment community failed to see this coming, and this is as true of retail investors as it is of leading analysts and economists. But of course this isn’t a one off. Look at virtually any 6-12 month period you care to choose, survey the best minds in the industry as to their expectations and then see how they do. The very fact that you always get a wide range of views will tell you right at the start that most forecasts are doomed to fail. In other words, they can’t all be right.
If this were to be the case with any other profession there would be outrage. Imagine if you went to 10 different doctors and you got 10 different diagnoses, most of which were wrong. What if you were to repeat the process every time you got sick and discovered that these doctors often varied in their opinion and rarely got it right? Moreover, what if no one particular doctor had any greater chance than the others of being correct? My guess is that you would stop listening to these people, and you would be right to do so.
But for some reason financial forecasters enjoy a special privilege where they are rarely held to account and, even more surprisingly, continue to attract a large audience eager for the next premonition. For a long time this didn’t make any sense to me.
I suppose part of the explanation lies in the fact that investors tend to have very selective memories. We remember those forecasts that were right, and quickly disregard those that failed. Perhaps we are accepting of mistakes because it is easy to rationalise why a particular forecast was wrong. “Sure, the market didn’t behave as expected, but that’s because earnings rebounded much stronger than anticipated.” Instead of saying the obvious, that the forecast was blatantly and unequivocally wrong, we instead say “well, it was a good forecast given what we knew at the time, and would have been accurate if only we had accounted for those better earnings.”
Do you see the beauty here? If I’m right I’ll gladly accept any praise and trumpet my soothsaying skills to the world. If I’m wrong, I can tell you why I was wrong, and then reinterpret the situation with the benefit of hindsight. In essence I can provide a neat little narrative that helps you to understand the past in a way that ‘makes sense’. This then is what we tend to remember, not the fact that forecast was horribly wrong.
The other get out of jail free card is the ‘better late than never’ phenomenon. A given prediction may fail to come to pass when expected, but if it comes along at all the forecaster can still claim some credit. For example, there were plenty of economists who called the US housing bubble as early as 2004. Sure, they were eventually ‘right’ in the sense that house prices were overvalued and would experience a correction, but that doesn’t change the fact that the initial forecast failed to foresee 3 more years of aggressive growth, that the housing correction would be as severe as it was, that it would lead to massive investment losses for the major banks, and that it would precipitate a severe equity market crash and crushing global recession.
It was Keynes who said it is better to be generally right than specifically wrong, but I think it’s a stretch to claim any prescience when only part of your forecast was right, and especially when the timing was wildly inaccurate. It may be better late than never, but that’s small comfort to anyone who acted on the advice at the time.
And that’s really the whole point. It is entirely sensible to listen to a range of forecasts and their supporting arguments, and if indeed you are convinced by them by all means put your money where your mouth is. But what you can never do is cry foul if expectations are not met, and you should certainly always account for the possibility of failure in your investment strategies.
That’s why we should diversify, even though we know that it will limit our upside as well as our downside. That’s why we never invest recklessly with money that we are relying on for other important things. That’s why we exit our positions if expectations are not met, instead of stubbornly holding out in the hope the market will turn. In the world of investment there is an expert on every corner with a viewpoint, and certainly some will make a better case than others, but ultimately it is YOU who decides what to do with your investment dollar, and you alone are responsible for that decision.
Forecasters really are blameless; they only provide a service that the market demands. Their only sin is sometimes having the arrogance to believe they have special powers of premonition beyond that of mere mortals. The fact is that as long as there is a demand for financial forecasts, there will always be a market ready to meet this demand. It isn’t the experts’ fault for outlining their expectations; it’s our fault for asking for them, even though we should know by now that they will most likely be wrong.
As the great philosopher Obi Wan Kenobi once said: “Who is more foolish? The fool or the fool who follows him?”
Make the markets work for you!
Andrew Page
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