The Rational Investor #018: Nate Silver on the “Perception” of Value of Forecasting
Happy Saturday to you,
Welcome to the 18th edition of The Rational Investor Newsletter.
Today’s quote appears in the book The Signal and the Noise by Nate Silver which is all about forecasting and learning to think in probabilities instead of certainties. If you’re a data nerd like me, you’ll love it.
In today’s passage, I want to highlight why forecasting has the perception of value, despite most forecasts being of negative value in practice. Silver shares examples from a wide variety of fields, including the stock market. But today’s quote is about weather forecasting and I think that this particular quote has significant applicability to the typical market forecasts we hear which I’ll share in my commentary.
(A quick aside: One reason this particular quote appeals to me is that one of my biggest pet peeves is a weather forecast with rain probabilities of either 100% or 0% that are then edited to something other than those two extremes—which intuitively should not be possible.)
Onto the main event… For context, the quote begins after Silver shared an evaluation of the accuracy of various for-profit and government weather forecasts.
Here’s Nate Silver on the Perception of Value of Forecasting [Bold emphasis is mine]:
“But the further out in time these models go, the less accurate they turn out to be. Forecasts made eight days in advance, for example, demonstrate almost no skill; they beat persistence but are barely better than climatology. And at intervals of nine or more days in advance, the professional forecasts were actually a bit worse than climatology.
…
Still, Floehr’s finding raises a couple of disturbing questions. It would be one thing if, after seven or eight days, the computer models demonstrated essentially zero skill. But instead, they actually display negative skill: they are worse than what you or I could do sitting around at home and looking up a table of long-term weather averages.
How can this be?
It is likely because the computer progams, which are hypersensitive to the naturally occurring feedbacks in the weather system, begin to produce feedbacks of their own. It’s not merely that there is no longer a signal amid the noise, but that the noise is being amplified.
The bigger question is why, if these longer-term forecasts aren’t any good, outlets like the Weather Channel (which publishes ten-day forecasts) and AccuWeather (which ups the ante and goes for fifteen) continue to produce them. Dr. Rose took the position that doing so doesn’t really cause any harm; even a forecast based purely on climatology might be of some interest to their consumers.
The statistical reality of accuracy isn’t necessarily the governing paradigm when it comes to commercial weather forecasting. [Editor note: Here comes the kicker…] It’s more the perception of accuracy that adds value in the eyes of the consumer.
For instance, the for-profit weather forecasters rarely predict exactly a 50% chance of rain, which might seem wishy-washy and indecisive to consumers. Instead, they’ll flip a coin and round up to 60, or down to 40, even though this makes the forecasts both less accurate and less honest.
…
Forecasts ‘add value’ by subtracting accuracy.”
Here is the applicability to becoming a more rational investor from my perspective:
1) Unlike the weather, the further out we look, the more accurate our “forecasts” are likely to be. For instance, I can’t tell you whether the stock market will go up or down tomorrow or this month (if it’s any comfort, neither can anybody else), but I feel quite confident that over 10, 20, 30 years, the market is likely to be up significantly. Exactly how much remains a mystery, but there’s a 97% chance or more that it will be higher based on historical norms.
2) Ironically, despite the truth of #1 above, market pundits spend nearly all their time “forecasting” the short-term (which is almost entirely unknowable) because there is “perceived value” even if their accuracy is often worse than a coin flip (see Superforecasting by Philip Tetlock). In other words, most people would prefer being wrong to dealing with short-term uncertainty. Of course, assuming you know something you don’t doesn’t dismiss the short-term uncertainty (it’s inherent), you’ve just now exposed yourself to an additional unnecessary risk that is, at best, dependent on a coin flip.
3) Lastly, and relevant to both points above, it’s better to be generally right (about the long-term) than precisely wrong (about the short-term). As it always will be.
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
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