The only function of economic forecasting is to make astrology look respectable.”
~ John Kenneth Galbraith
Should You Ignore the Pundits?
It's that time again, when the market pundits release their investment outlooks and predictions for the upcoming year. In fact, the only thing that will show up in your inbox more frequently than investment outlooks will be articles about how you can safely ignore them. The objections usually include that markets are unpredictable and nothing destroys portfolio balances faster than random guesses from know-nothing strategists. Whether these are genuine warnings or just a chance to sound snarky and contrarian, a cottage industry has developed to warn investors about the evils of annual market outlooks.
As a producer of such commentary, I have mixed feelings on the subject, but with that caveat, here’s my take on the pros and cons of market predictions and outlooks.
Let's start with the downside: Pure market predictions are pretty useless. These are usually declarative sentences, or worse, point estimates that ooze with certainty. Volume implies confidence, so the louder and brasher the better. (It helps social media velocity too.) But guesses dressed up with confident language are still guesses. Examples in this genre include "Double-digit returns for stocks!" or "Oil to rocket above $100/barrel." Assertive forecasts, specific index levels, or price targets give an air of authority but fundamentally miss the point: All good predictions are probabilistic, because outside of math and physics, little is known with certainty. Be wary of statements claiming that something either will or won't happen. Yes, I understand why investors and the financial media crave the appearance of certainty, and we fall into this trap from time to time as well. However, I believe the best forecasts acknowledge uncertainty and are tempered by ranges, probabilities, and qualifying statements. Some things may be more or less likely to happen, but nothing is guaranteed.
Beyond forecasts and outlooks, the more insidious effect of portraying certainty is that it breeds overconfidence. This arrogance can have meaningful negative consequences for portfolios such as reducing diversity, increasing leverage, or taking on an inappropriate level of risk.
The Importance of Why
So what about the upside? The most valuable element of an investment outlook is the rationale for the opinion or views. Exactly what the experts think isn’t nearly as important as why they think it. All forward-looking commentary provides an opportunity to evaluate the author's rationale relative to your own understanding of market circumstances and dynamics. Is it logical? Is the fact pattern consistent? Is the view already priced in? Does the opinion follow from the argument presented? The real insight for investors lies in the author’s reasoning, not in shrill predictions.
For example, when I wrote our market outlook for 2019, I argued that the global economy was decelerating and that for the first time in many years, interest rates were more likely to fall than rise, if only modestly. These views turned out to be directionally accurate, but wow, did we miss on the magnitude. Rates across the developed world did not “fall modestly” – they plunged.
But again, forecasting an uncertain future doesn't lend itself to this level of precision. Readers should assess our rationale and the quality of the arguments presented. What evidence did we use to argue that the global economy was decelerating? Why did we believe the Fed would pause? What reasoning did we offer for lower rates? Did it logically follow that slower growth meant less inflation? Did we account for what the market had already priced in? We could go on, but you get the point: The rationale and thought process is where the learning takes place, not the forecast. You’d be amazed at what you can learn from a well-reasoned forecast that turns out to be incorrect.
Because market prognostications are such an inexact science, buy-and-hold purists will undoubtedly remind us that it’s probably best just to ignore those year-end outlooks. Eschew the pundits, hold for the duration, and take a long-term view – or so the classic theory goes. Yet while tempting, this argument has its own flaws. All portfolio investments are effectively "bets." For example, if you invest in stocks "for the long run" and buy/hold/rebalance, you've made an implicit bet that equity returns will be higher than other assets over the long haul – along with a host of other assumptions. The fact that your investment wasn't justified in advance by an explicit forecast or prediction is irrelevant. An implicit guess is still a guess. On the other hand, a forecast with a well-constructed rationale is an educated guess – and one that may provide additional insights. In this era of transparency and fiduciary responsibility, investors should value a thoughtful rationale – imperfect as it may be – to support their portfolio allocations.
So if you have the inclination, read the outlooks you can – particularly those from people who challenge your point of view. But do it with a healthy dose of skepticism. Markets are highly unpredictable. We're all guessing to some extent. Judge us by our arguments and theories, and watch for our 2020 Outlook in the coming days.
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