Why We Don’t Make Forecasts
Advice from Janet Yellen and a Spectacular Zero
At the end of this post, I’ll explain the picture above and the advice Janet Yellen gave me.
To start, though, our firm constantly gets asked what we think is going to happen to the market going forward or for our picks of stocks, sectors, or asset classes that we think are going to perform the best.
We know that most everyone likes to hear a hot tip, and earlier in our careers, when big Wall Street firms paid us to do this, we tried to provide them.
Now, we are older and don’t care as much about impressing people. In addition, we hope that our clients pay us to shoot straight, tell them what we really think, and stay focused on the consistent findings of independent peer-reviewed research – not selling forecasts.
What do we say now based on our experience and the evidence about what’s most likely to come to pass?
As I encouraged more investment professionals to say when I recently spoke at the CFA’s annual wealth management conference…
We Don’t Know
We’re sure a few people think that when we do this we are taking the easy way out or being passive in our approach to investing.
I understand why people might feel this way, especially when the word “passive” is used. According to the dictionary, passive means “inert” and has synonyms such as “acquiescent” and “compliant.”
Until very recently, and only due to more and more candid comments from people like Warren Buffett, the investment industry socialized both investors and industry professionals to believe that significant weight and value should be placed on estimates and projections.
What does the evidence consistently show, however, about the accuracy of forecasts and analysts’ recommendations?
Like the old saying that is echoed frequently inside Wall Street, the presenters are never in doubt, but often wrong.
I’ve written about this topic frequently for Trusts & Estates magazine and the CFA Institute, and even shared over-cocktails quotes from what we called the Honest Global Chief Investment Officer in our blog piece, Talking Heads.
We know we are fighting a constant battle against the financial public relations machine, though, so below are a few more pieces of evidence supporting our contrary-to-the-herd point of view.
First, to independent research produced by Salil Mehta, who has been collecting data on the accuracy of Wall Street forecasts for over 20 years. In one of his most detailed pieces, Desolated Admirers of Investment Strategists, he highlights compelling long-term data. It includes this line.
What Emperors Hope You Forget
As Mehta discusses, people generally don’t care much about predictions in an up-market. Even though bull market prognostications have been shown to be less accurate than a coin toss, if the market is up, investors tend to be quite forgiving. Last year was a good example. The U.S. equity market was up over 20% in 2017, but many on Wall Street predicted only single-digit returns.
People focus more on pain avoidance, meaning that what investors really care about is downside protection – advice about when to sell before a bear market.
What does Mehta’s research show about how many times Wall Street consensus predicted a market drop?
A Spectacular Zero
Unfortunately, this has been well-known but kept quiet.
As an example, CXO Advisory collected data from over 6,500 predictions made by 68 investment gurus covering the time period 1998 – 2012.
What did they find?
The accuracy of well-known investment strategy professionals, including industry luminaries Jeremy Grantham and Abby Joseph Cohen, was only 47% (see the following for the complete study – Guru Grades).
Next, we looked at these market movers that are constantly making news with their economic and interest rate projections.
Federal Reserve Leaders
On this group, take a look at the chart below. It’s from a Wall Street Journal analysis of over 700 Fed policymaker predictions between 2009 and 2012. As you might expect, 1.00 is perfect, so it acts as a percentage accuracy score.
These data suggest that my picture mate, Yellen, is indeed impressive relative to her peers, but the last we checked, an accuracy rating of 52% was not very high.
We certainly have a lot of respect for the Fed, read their publications, and watch their press conferences but, before you think that we’re being too hard on them, they acknowledge that their forecasting leaves much to be desired.
As an example, the following is from a report published in February of 2015 by the Federal Reserve Bank of San Francisco based on a study of the Federal Reserve Open Market Committee’s Summary of Economic Projections (SEP):
“The SEP forecast did not anticipate the Great Recession that started in December 2007…”
Yellen then reinforced this herself in a 2010 comment when she acknowledged that…
“[We] didn’t see any of that coming until it happened.”
The evidence suggests that market and economic forecasts aren’t worth much, but this doesn’t mean you shouldn’t look at data. Data can absolutely help you develop a long-term plan you feel comfortable enough to stick with and not change based on short-term predictions.
Like the enduring design approach of Steve Jobs, the best financial strategies evaluate all kinds of data then strip away everything that isn’t in simple service of the underlying goal.
It might sound overly simplistic or passive, but as we detailed again this year in a piece for Trusts & Estates magazine titled, An Important Lesson, keeping it simple has consistently outperformed even top university endowments over multiple rolling long-term time periods.
Our Advice and That Of Yellen
The next time you hear an emotional investment forecast, stay anchored on what Janet Yellen privately cautioned me – with a smile – after she shared her current market view.
“Just remember, my projections are based on estimates – yes, estimates based on estimates – and my assessments contain a considerable amount of uncertainty.”
Related Reading:
Equity Analysts: Still Too Bullish – McKinsey Quarterly
The Road Less Traveled – Simple Alternatives 
Are Most Investment Managers One Hit Wonders? 
The Certain Drag on Performance – Taxes