If successful investing was as easy as acting on the headlines of the financial press or the latest stockbroker bulletin, we’d all be wealthy indeed. Very wealthy and very successful. Imagine how easy it would be to simply read headlines such as: ‘USD to rise’, ‘Gold to Break $2,000’, ‘Stock Market Crash Imminent’, ‘Company XYZ a BUY, Price Target $152’, and then upon taking action, turn those forecasts into success. Every single time. Sound too good to be true?
Unfortunately it is.
Forecasting is an art, not a science and as such, its incredibly hard to be accurate 100% of the time. Actually, when you think about it, its hard to be right even part of the time. Forecasting, at best, is just a considered guess, and when you look at the actual definitions of those two words, you’ll see there’s actually not much difference:
Forecast: “predict or estimate (a future event or trend)”.
Guess: “estimate or conclude (something) without sufficient information to be sure of being correct.”
In the end, they’re both estimates, yet we’re often led to believe that the person making the estimate must have some foresight we don’t. Unfortunately the truth is, ordinarily they don’t.
If investors demanded those publishing the forecasts to include their track record, life would be much simpler. I’m not suggesting forecasting is easy, but the confidence and precision portrayed by so-called experts reminds me of the charlatans who peddled their ‘miracle cures’ before medicine became a science.
“We always read ‘I think the stock market's going to go up.’ We never read ‘I think the stock market’s going up, (and 8 out of my last 30 predictions were right) or ‘I think the stock market's going to go up (and by the way I said the same thing last year and was wrong).’ Can you imagine deciding which baseball players to hire without knowing their batting averages? When did you ever see a market forecaster's track record? “ Howard Marks
"The greatest folly is to accept expert statements uncritically" Garrett Hardin
In over a quarter of a century in the finance industry, I’ve pretty much seen it all. Consider this recent forecast in Barron’s … 'Tesla is headed to $10 a share under a bearish case—or $391 under a bullish one, wrote [an] analyst this week’. The stock was around $200 at the time. I thought to myself, $391, that’s rather precise. No rounding required? Maybe $400? And the downside as low as $10? Yet that outcome seemed unlikely. Not because it was too bearish, but a glance at the debt load suggested to me that if the bearish case developed, the light will bypass yellow and go straight to red from green. And the analyst range of $10 to $391? I’m not sure how to make money out of that one, but given the possibility of losing everything, maybe it’s a stock to avoid?
The above statement can be best described as a guess. When we look into the future that’s what we’re all really doing. Guessing.
William Stewart, the founder of Stewart Asset Management, has bettered the S&P500 by a remarkable 4.3%pa net for 40 years! In a recent Graham & Doddesville interview he proffered:
“This is not a science but more of a guessing game. We try to make the best guesses we can.” William Stewart
“What you’re really doing is laying out your decision tree and adjusting it. You can come back saying, I think I got this a little high, or that a little low. It’s not fixed. In essence, we’re always operating with the best guess we can make. If it changes weekly, it changes weekly. It doesn’t usually change weekly, but it could. Nobody’s got a lock on what’s right, a model is only a model and it’s not fixed in stone. Sometimes, nothing’s changed but you changed your mind. That’s good. The purpose of the process is to bring out our best guesses. Everything we do is guessing. I think we all get a little carried away with the science of the matter, because there are lots of formulas, whereas you’re essentially making a guess.” William Stewart
Because we don’t have perfect information and because we can never know the future, a model capable of predicting an exact target price is fiction; even a 5,000 line spreadsheet model! Because businesses are unpredictable, some more so than others, asset price targets or intrinsic values can’t be set in stone; regardless of what their makers and promoters hope to convey.
We won’t know if a stock price was a reasonable reflection of a company’s value until some future date. So today, a stock price is just a fictional analog of the underlying company it represents.
The benefit of approaching investing with a ‘guessing’ mindset is that it removes the shackles of perfection. It provides for the possibility of being wrong and in doing so, it helps avoid confirmation and commitment biases.
"You need humility to say 'I might be wrong'.'' Seth Klarman
"Every day I assume every position I have is wrong." Paul Tudor Jones
William Stewart‘s quote took me back to one of my favourite books, ‘Super-Forecasting’, by Philip Tetlock. Tetlock’s observation about ‘guesses’ is an apt one.
“Probability judgements should be explicit so we can consider whether they are as accurate as they can be. And if they are nothing but a guess, because that’s the best we can do, we should say so. Knowing what we don’t know is better than thinking we know what we don’t.” Philip Tetlock
I’ve included some of my favourite quotes from Tetlock’s book below. I hope they’ll help guide you the next time you’re presented with an ‘expert’ forecast, or even if you’re attempting to develop your own.
Check The Forecasters’ Record
“Every day, the news media deliver forecasts without reporting, or even asking, how good the forecasters who made the forecasts really are.”
“Many have become wealthy peddling forecasting of untested value to corporate executives, government officials, and ordinary people who would never think of swallowing medicine of unknown efficacy and safety but who routinely pay for forecasts that are as dubious as elixirs sold from the back of a wagon.”
“The list of organisations that produce or buy forecasts without bothering to check for accuracy is astonishing.”
“Consumers of forecasting will stop being gulled by pundits with good stories and start asking how their past predictions fared - and reject answers that consist of nothing but anecdotes and credentials.”
“Far too many people treat numbers like sacred totems offering divine insight. The truly numerate know that numbers are tools, nothing more, and their quality can range from wretched to superb.”
Most Forecasts Are Quickly Forgotten
“Old forecasts are like old news - soon forgotten - and pundits are almost never asked to reconcile what they said with what actually happened.”
“More often forecasts are made and then .. nothing. Accuracy is seldom determined after the fact and is almost never done with sufficient regularity and rigor that conclusions can be drawn. The reason? Mostly it’s a demand-side problem: The consumers of forecasting - governments, business, and the public - don’t demand evidence of accuracy. So there is no measurement.”
Forecasting is Often Impossible
“It’s misguided to think anyone can see very far into the future.”
“It’s a rare day when a journalist says, ‘The market rose today for any one of a hundred different reasons, or a mix of them, so no one knows’.”
“Uncertainty is real. It is the dream of total certainty that is an illusion.”
“Limits on predictability are the predictable results of the butterfly dynamics of non-linear systems.”
“If you have to plan for a future beyond the forecasting horizon, plan for a surprise.”
“The past did not have to unfold as it did, the present did not have to be what it is, and the future is wide open. History is a virtually infinite array of possibilities.”
Stay Open-Minded, Curious and Self Critical
“Super-forecasting demands thinking that is open-minded, careful, curious, and - above all - self critical. It also demands facts. The kind of thinking that produces superior judgement does not come effortlessly.”
“The strongest predictor of rising into the ranks of super-forecasters is perpetual beta, the degree to which one is committed to belief updating and self-improvement. It is roughly three times as powerful a predictor as its closest rival; intelligence.”
Seek Dis-Confirming Evidence
“Scientists must be able to answer the question “What would convince me I am wrong?” If they can’t it’s a sign they have grown too attached to their beliefs.”
“We rarely seek out evidence that undercuts our first explanation, and when that evidence is shoved under our noses we become motivated skeptics - finding reasons, however tenuous, to belittle it or throw it out entirely.”
“People can be astonishingly intransigent - and capable of rationalizing like crazy to avoid acknowledging new information.”
“Social psychologists have long known that getting people to publicly commit to a belief is a great way to freeze it in place, making it resistant to change. The stronger the commitment, the greater the resistance.”
“Super forecasters may have a surprising advantage; they’re not experts or professional, so they have little ego invested in each forecast.”
Beware High Confidence
“Declarations of high confidence mainly tell you that an individual has constructed a coherent story in his mind, not necessarily the story is true.”
“People trust more confident financial advisers over those who are less confident even when their track records are identical.”
Intuition is Pattern Recognition
“There is nothing mystical about an accurate intuition .. it’s pattern recognition. With training or experience, people can encode patterns deep in their memories in vast numbers and intricate detail - such as the estimated fifty thousand to one hundred thousand chess positions that top players have in their repertoire. If something doesn’t fit a pattern, a competent expert senses it immediately.”
Wrong Outcome Doesn’t Imply Wrong Forecast
“If the forecast said there was a 70% chance of rain and it rains, people think the forecast was right; if it doesn’t rain, they think it was wrong. This simple mistake is extremely common.”
& Vice Versa
“People often assume that when a decision is followed by a good outcome, the decision was good, which isn’t always true, and can be dangerous if it blinds us to the flaws in our thinking.”
Words, Numbers and Time Matter
“Study after study showed people attach very different meanings to probabilistic language like “could”, “might,” and “likely.”
“Forecasts must have clearly defined terms and timelines. They must use numbers.”
“Fuzzy thinking can never be proven wrong. And only when we are proven wrong so clearly that we can no longer deny it to ourselves will we adjust our mental models of the world - producing a clearer picture of reality. Forecast, measure, revise: it is the surest path to seeing better.”
More People ≠ Better Forecasts
“Aggregating the judgments of many people who know nothing produces a lot of nothing.”
Models are Models
“No model captures the richness of human nature. Models are supposed to simplify things, which is why even the best are flawed.”
Forecasts Are To Foresee
“The point of making forecasts is not to tick all the boxes on the ‘how to make forecasts’ checklist. It is to foresee what’s coming.”
Sample Size & Randomness Matter
“Someone beats the market six or seven years in a row, journalists profile the great investor, calculate how unlikely it is to get such results by luck alone, and triumphantly announce that it’s proof of skill. The mistake? They ignore how many people were trying to do what the great man did. If it’s many thousand, the odds of someone getting that lucky shoot up.”
You Can Get Caught by Stories
“It’s natural to be drawn to the inside view. It’s usually concrete and filled with engaging detail we can use to craft a story about what’s going on. The outside view is typically abstract, bare, and doesn’t lend itself so readily to storytelling.”
Test & Debate Views
“Super forecasters constantly look for other views they can synthesis with their own. There are many different ways to obtain new perspectives. What do other forecasters think? What outside and inside views have they come up with? What are the experts saying? You can even train yourself to generate different perspectives.”
“For super forecasters, beliefs are hypotheses to be tested, not treasures to be guarded.”
“If forecasters can keep questioning themselves and their team mates, and welcome vigorous debate, the group can become more than the sum of its parts.”
Assume You’re Forecast is Wrong
“Researchers have found that merely asking people to assume their initial judgement is wrong, to seriously consider why that might be, and then make another judgement, produces a second estimate which, when combined with the first, improves accuracy almost as much as getting a second estimate from another person.”
“Learning to forecast requires trying to forecast. Reading books on forecasting is no substitute for the experience of the real thing.”
“Our expectations of the future are derived from our mental models of how the world works, and every event is an opportunity to learn and improve those models.”
“To learn from failure, we must know when we fail.”
“Unfortunately, most forecasters do not get high-quality feedback that helps meteorologists and bridge players improve. There are two main reasons why. Ambiguous language is a big one. Vague terms like ‘probably’ and ‘likely’ make it impossible to judge forecasts. The second big barrier to feedback is time lag. When forecasts span months or years, the wait for a result allows the flaws of memory to creep in.”
“Once we know the outcome of something, that knowledge skews our perception of what we thought before we knew the outcome; that’s hindsight bias.”
“Underlying super-forecasting is a spirit of humility - sense that the complexity of reality is staggering, our ability to comprehend limited, and mistake inevitable.”
The front pages of yesterday’s financial papers and brokerages bulletins are littered with stock recommendations that resulted in permanent loss of capital. Why? Because for most forecasters, it doesn’t matter. It’s wasted ink not money. New Price target 50% of Old Price Target. Has the model been changed? The old model didn’t work?
When you don’t have a position, you just have an opinion. It’s for this reason I prioritise information from investors with skin-in-the game and long track records of success.
The next time you’re presented with a forecast, take the time to consider the forecasters track record of success, and also why they might be making such claims. Remember, if their guess is right, they’re seen as a guru; if they get it wrong nobody remembers anyway.
I’ll let Morgan Housel have the last word on this topic:
“You don’t get on TV, or invited to industry conferences, or big book deals for predicting average outcomes. Pundits get paid for sitting three standard deviations away from sane analysts.”
Source: ‘Superforecasting: The Art and Science of Prediction’ Philip Tetlock, Dan Gardner, Broadway Books, 2016.
Further Reading: Investment Masters Class Tutorial - ‘Forecasting’
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