Don’t believe the forecasters

A blind-folded businessman about to throw a dart © Getty images
He’s better at predictions than the professionals

Analysts are always telling us what they think is about to happen to economies or equities. Ignore them.

“The only function of economic forecasting is to make astrology look respectable,” said JK Galbraith. Investors are constantly bombarded with predictions about stockmarket index gains or losses, corporate earnings or macroeconomic developments – so it’s important to keep in mind (especially if you’re a picky, over-analysing Virgo like me) that they can be safely tuned out.

“The data overwhelmingly shows that as a species, we are simply awful at [forecasting],” says Barry Ritholtz on Bloomberg. Let’s start with the economy. The International Monetary Fund (IMF), the European Commission and the US Federal Reserve all missed the global financial crisis. Despite ample evidence of financial turbulence, in the spring of 2008 the European Commission predicted that the eurozone would expand by 2% that year and 1.8% the next. The actual respective figures were 0.4% and −4.5%. Analysts also missed the oil-price collapse of 2014.

Every Christmas investment banks and fund managers produce stockmarket index targets for the year ahead. One study of S&P 500 predictions made by 22 strategists at major investment banks between 2000 and 2014 revealed that they were off by an average of 14.6% a year. They didn’t foresee a single negative year, even though the span included a market slide of around 60% in 2008/09. They also underestimated good years.

Stock ratings aren’t much help either. Stockbroker AJ Bell notes that the ten stocks in the FTSE 100 that received the highest proportion of “buy” ratings from analysts fell by an average of 9.5% in 2017. The ten with the most “sell” ratings actually rose by a similar average amount.

In short, a blindfolded child throwing darts at a board is likely to give you a better idea of how indices or economies might move. A key problem is the herd mentality. Analysts cluster together (if everyone gets it wrong, you won’t get fired) and the group instinctively resorts to extrapolating the trend of the recent past because this is the safest, least controversial approach. They are also too cheerful because predictions tend to be part of a marketing effort.

Furthermore, the year or so these forecasts cover is a very short time in which just about anything can happen to throw predictions off course. Knowing what the consensus is expecting may help you anticipate a short-term slide or bounce when the figures are under- or overshot. But investing is about years and decades, and as we often point out, valuations are the best guide to long-term stockmarket movements. Short-term market and economic forecasts need not feature in your research.