EC Is Forecasting Always A Folly?
Forecasting season is upon us. Anyone who gets to be quoted in print or speak to a reporter is asked an opinion. Expertise not required! It is paradise for pundits.
Many have decried the “folly of forecasting.” People love to laugh at supposed experts, looking back at old forecasts. Since most forecasts are based upon a model, modelers are thrown under the bus as well.
Barry Ritholtz wrote on this topic in his excellent Apprenticed Investor series. There are now over 200,000 blog hits on this phrase.
But please consider this: Most models and forecasts are bad – very bad – but not all. The trick is to figure out which is which. Barry notes the possible exceptions:
There are only two kinds of predictions that have some value to investors: One is probability-based, and the other is risk-based. If you apply the same rules — no one knows the future, they are subject to revision and should not be taken as gospel — then these are sometimes worth considering.
Here are a few examples.
- Millions of people attempt to paint, but only a handful are successful. Could you pick the winners?
- Millions attempt to write, but there are few best-sellers. Could you guess them in advance?
- Worldwide wine consumption is over 30 billion bottles. How many are really good?
- In the U.S., 11 million people are playing baseball in a given year. Fewer than 900 are in the major leagues. There is so little difference that only an expert could identify the best players by watching them bat.
Finding the best in any large field is a real challenge!
The issue is especially important for financial analysis. I have been pondering this question for weeks. How can I best explain an important but unpopular viewpoint? I recently began this theme with by citing a bogus analysis in the New York Times. In simple fashion, I showed that if you only had the long-term average – that the market returned a positive result 2/3 of the time – you would do much better to predict “Up” every year rather than guessing 2/3 up and 1/3 down. This counter-intuitive result should be cause for thought, since it is an expensive and common investor mistake.