Shouldn’t the role of economists be limited to explaining data and to stay away from forecasting? Forecasting is something they are terrible at. They seem to consistently crowd as a group at the wrong answer. Usually when people are consistently bad at something they stop doing it. But economists feel it is their job (their raison d’etre?) to continue. Indeed we demand it from them.
Those who have knowledge don’t predict. Those who predict don’t have knowledge” – Lao Tsu 6C BC
Forecasting track record
In a blog post I published in April 2014, I wrote “This doesn’t happen very often. Marketwatch reports that Jim Bianco points out in a recent market comment that the 67 economists taking part in a regular Bloomberg survey have a unanimous forecast regarding treasury bond yields: they will be higher 6 months from now. This is a truly striking result, and given the well-known propensity of mainstream economists to guess wrong (their forecasts largely consist of extrapolating the most recent short term trend), it may provide us with a few insights.
In fact, considering that there have been only a handful of instances since 2009 when a majority of the economists surveyed predicted a decline in yields, we can already state that their forecasts regarding treasuries are quite often (though obviously not always) wide of the mark. In fact, so far this year (2014) they are already wrong again – and so are fund managers, as they hold their lowest exposure to treasuries in seven years. This is not the only thing there is complete unanimity about. Not a single economist taking part in a separate survey believes an economic downturn is possible.”
Analysts are no better. According to James Montier, the Behavioural Finance expert and Extel top rated strategist, (analysts) forecasting record is simply dreadful on both short- and long-term issues. when an analyst first makes a forecast for a company’s earning two years prior to the actual event, they are on average wrong by a staggering 94%. Even in a 12-month time horizon, they are wrong by around 45%! “To put it mildly, analysts don’t have a clue about future earnings.”
Despite their poor track record they have a great tenancy to display over confidence in their ability by being incredibly precise about their forecast. They will often make forecasts to two decimal places or very precise dates for events making their predictions wrong. If they just displayed a little narrow prediction they will be right more often. Sometimes the precision of the forecast is ridiculously precise and is almost certain to be wrong. Why do this? Why not accept the forecast is a guess and widen the range of the answer?
Why do they do it?
Studies continually show how poor they are at predicting(1) but also that they have an unshakable faith in their ability to predict. Presented with predictions that they were 80% sure were correct which were wrong (nearly half the time) they show no signs of shaking their faith in their ability to forecast. Their most common excuses for getting it wrong fall into these categories:
1. They claim that if their advice had been followed, they would have been right. “If the Fed had raised rates then my prediction would have been true”
2. Something unexpected happened and so it was not their fault.
3. Although the prediction was wrong, “I was almost right”.
4. “My prediction has not happened as predicted but it just has not happened yet. It will.”
5. “Don’t judge me by this single prediction. I am overall good at predicting.”
We get the forecasts because we need them
Economists and analyst make these forecasts because we demand them of them. We need to believe there are experts who can predict and we want to cling to their words and forecasts despite the clear evidence being they are not better than a coin toss in making predictions. We need the comfort of believing there is someone who knows the future, particularly if their opinion agrees with our own. Gurus are created because we need them.
As a technical analyst I do not make forecasts. i realise how difficult (impossible) it is to forecast the future. I do knew that the market discounts everything in the prices, not only the facts but also participants hoes, fears and expectations for the price. I know trends exist and they have a tenancy to persist. I also know that markets forms patterns and they often repeat. This is enough of an edge to understand what is happening and how to trade or invest. I know for sure, I have no idea where the FTSE will be in 12 months time.
See also April 2014 blog post
(1) See for example Philip Tetock, “Theory-Driven Reasoning about Plausible Pasts and Probable Futures in World Politics” 2003