No Crystal Balls – Just Peace Of Mind
Just as the weather is uncertain and sometimes unpredictable, the market time and time again reminds us that economic and geopolitical volatility are constants and that outcomes cannot be predicted.
People often ask us our opinions about the market. We are happy to give our two cents but we always remind them that we do not have a crystal ball.
Economists and market strategy professionals are constantly trying to forecast what the future will bring. Unfortunately, we find that prognosticators are never in doubt but often wrong.
For more on this reference the chart below illustrating the accuracy of forecasting, which we published initially in our blog, “If We Had A Chief Economist We Would Have To Pay Them“.
Federal Reserve Bank of San Francisco – February 2015
Below are comments that the Federal Reserve Bank of San Francisco (FRBSF) made about this chart and their own projections, which they call the SEP:
“Over the past seven years, many growth forecasts, including the SEP’s…, have been too optimistic. In particular, the SEP forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently over-predicted the speed of the recovery that started in June 2009.”
“Figure 1 shows that the SEP growth forecast for 2008 never turned negative. At the time, the mainstream view was that the U.S. economy would avoid a recession despite the ongoing housing market turmoil. The actual growth rate for 2008 turned out to be -2.8% (the largest annual decline since 1946). The SEP growth forecast for 2009 did not turn negative until January 2009…, after the Lehman Brothers bankruptcy in September 2008.”
For those you wish to read the full report, it can be found by clicking on the following link:
FRBSF Economic Letter – Persistent Overoptimism About Economic Growth – February 2, 2015
Some might say, “recent predictions don’t tell the full story”, “the 2008-2009 financial crisis was hard to predict” or, my favorite, “economics are indeed hard to predict, but with hard work our analysts can accurately estimate future earnings”.
Unfortunately, independent analysis of analysts’ estimates and projections paints a consistent picture. They are often wrong at the wrong time.
As an example, McKinsey & Co. (one of the most respected consulting firms in the World), produced a study in 2001 about the accuracy of earnings estimates, which was then updated in 2010. The following quote summarizes their findings:
“Analysts, we found, were typically overoptimistic, slow to revise their forecasts to reflect new economic conditions, and prone to making increasingly inaccurate forecasts when economic growth declined. On average, analysts’ forecasts have been almost 100 percent too high.”
Like the FRBSF chart, pictures can speak louder than words. In the chart below, the light green line represents Wall Street earnings forecasts. The blue line reflects what actually happened.
The full McKinsey & Co. reports can be found at the following:
Equity Analysts: Still Too Bullish – McKinsey Quarterly – April 2010
Prophets and Profits – McKinsey Quarterly – October 2001
If investment forecasts predict outcomes as poorly as the chart above reflects, what should you do?
As you do with the weather, respect the fact that conditions can change rapidly.
Be prepared and stay broadly diversified. Don’t reach for returns. Keep focused on your long-term plan. Don’t be sold the hot investment strategy. And remember the following very old saying:
“I thank my fortune for it,
My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year:
Therefore my merchandise makes me not sad.”
Merchant of Venice – Shakespeare
In a nutshell, “don’t put all your eggs in one basket”.
The following are ten additional thoughts that we think are good general rules successful long-term investing:
Ten Rules To Consider
- Investing is not a competition – Invest for your goals and stick to your plan.
- View risk in terms of evaluating the likelihood of, and your ability to handle, the permanent loss of capital – Risk is not the variation of returns or standard deviation.
- Do not run with the herd – Be contrarian.
- Be curious, understand the position of the person or firm producing the research and remember that many investment theories are, well, theories.
- Be patient – True long-term investors often come in for the most criticism but produce the greatest good (thank you Sir. Keynes).
- Avoid leverage – It can offer more upside but the risk of the loss of capital is often not worth the reward
- Understand liquidity – It should always be placed at a premium.
- Don’t forget taxes – Many great sounding strategies don’t factor in the impact of Uncle Sam (see our past “What Would Yale Do If It Was Taxable” post).
- Only invest in what you understand – Do not be sold.
- History tends to repeat itself or at least rhyme (thank you Mr. Twain) – Try to learn from the past mistakes of others – The investment world certainly offers us many mistakes to learn from.
Finally, please consider only investing in what makes you feel comfortable. Demand transparency and remember that simplicity often wins over complexity.
I cannot promise that these rules will always bring you the highest returns, but experience has taught me that they can help investors achieve goals and increase peace of mind.
What is comfort and peace of mind worth?
I am not sure but for many, in a world that is pretty fast paced and complex, it might be like the Master Card ad:
“Priceless”
Related Reading:
The Road Less Traveled – Simple Alternatives 
Are Most Investment Managers One Hit Wonders? 
The Certain Drag on Performance – Taxes