The Rational Investor #039: Forecasts are Worse Than Useless
Happy Saturday to you,
Welcome to the 39th edition of The Rational Investor Newsletter.
Because I believe that acting on forecasts is a path to investing oblivion, I was delighted to see such a statistical takedown of forecasting—citing multiple studies in sequence—in Dr. Daniel Crosby’s new forthcoming book, The Soul of Wealth, which is available for pre-order as we speak.
I’m thankful that Daniel was generous enough to share a copy with me, and it’s excellent. In full disclosure, he did not ask that I blurb his book, and I am not being compensated in any way.
I simply wanted to share it with you because it’s filled with countless financial studies, stories, and stats that you will find interesting, not to mention many other counterintuitive ideas.
As a few examples of counterintuitive ideas, you’ll find chapter titles such as Giving Is The Path To Abundance, Investing Is An Act of Radical Optimism, and Money Can Buy Happiness When You Spend It Correctly.
Long story short, if you enjoy great studies, stats, and countercultural ideas, you will enjoy this book. With that said, let me share a few paragraphs where Dr. Daniel Crosby roasts the forecasters.
The only change I’ve made to the quote is to break up the paragraphs to make it more readable here.
Here we go…
Here’s Dr. Daniel Crosby on Why Forecasts are Worse Than Useless:
“The Wall Street Industrial complex gives off the air of imporance, with its marble edifices, highly compensated experts, and 24/7 cable news shout fests. But a look under the hood shows that much of what passes for white-shoe research is little more than noise.
In The Laws of Wealth, I cited evidence buttressing the argument that financial outlooks are worth less than the paper on which they are printed. Let’s review that again now.
Contrarian investor David Dreman found that most (59%) Wall Street ‘consensus’ forecasts miss their targets by gaps so large as to make the results unusable. These CFA pros either under or overshoot the actual number by more than 15%.
Dreman dug deeper and found that from 1973 to 1993, the nearly 80,0000 estimates he reviewed had a mere 1-in-170 chance of being within 5% of the actual number. We can glean two conclusions: (1) Forecasting is hard; and (2) Wall Street experts make a lot of noise.
Economist and author James Montier sheds light on the difficulty of forecasting in his Little Book of Behavioral Investing. In 2000, the average target price of stocks was 27% above the market price—prices ended up higher by just 16%. In 2008, the average forecast was a 28% increase—the market would go on to decline by 40%.
More broadly, a study conducted by Michael Sandretto of Harvard and Sudhir Milkrishnamurthi of MIT analyzed one-year forecasts for the 1,000 most widely covered companies by analysts. They found that analysts were consistently inconsistent, missing the mark by an annual rate of 31.3% on average.
And how about this: The 2020 consensus return estimate for the S&P 500 was about 3%—the actual gain was 16%, with a 34% crash tossed in partway through the year.
What’s even more hilarious to consider is how much worse the estimates would have been had the forecasters known that we would endure a global pandemic that year that would shut down the economies of the world. The research is unequivocal—forecasts don’t work and, as a corollary, neither do the investment schemes that rely on them.”
Lest you be lulled into thinking that forecasters have improved over time with the availability of more information, look no further than the forecasts from the “world’s foremost experts” this year alone (image from Charlie Bilello).
The results were almost identical last year. And to state this as clearly as possible, almost all of them drastically miss the mark each and every year. It’s honestly remarkable how wrong they are, and yet, people continue to listen to their gibberish. My message today is, don’t let that be you.
Thanks for reading. I’ll be back again next week with more timeless wisdom from great investors.
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