2017 Resolutions – Distrust Forecasts

This is the time of year where lots of stray forecasts get given.  I got tired enough of it, that I had to turn off my favorite radio station, Bloomberg Radio, after hearing too many of them.  I recommend that you ignore forecasts, and even the average of them.  I’ll give you some reasons why:

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  • Most forecasters don’t have a good method for generating their forecasts.  Most of them represent the present plus their long-term bullishness or bearishness.  They might be right in the long-run.  The long-run is easier to forecast, in my opinion, because a lot of noise cancels out.
  • Most forecasters have no serious money on the line regarding what they are forecasting.  Aside from loss of reputation, there is no real loss to being wrong.  Even the reputational loss issue is a weak one, because Wall Street generally has no memory.  Why?  Enough things get predicted that pundits can point to something that they got right, at least in some years.  Memories are short on Wall Street, anyway.
  • The few big players that make public forecasts have already bought in to their theses, and only have limited power to continue buying their ideas, particularly if they are wrong.  This is particularly true in hedge funds, and leveraged financial firms.
  • Forecasts are bad at turning points, and average forecasts by nature abhor turning points.  That’s when you would need a forecast the most, when conditions are going to change.  If a forecast presumes “sunny weather” on an ordinary basis it’s not much of a forecast.
  • Most forecasters only think about income statements.  Most of the limits stem from balance sheets proving insufficient, or cash flows inverting, and staying that way for a while.
  • Most forecasts also presume good responses from policymakers, and even when they are right, they tend to be slow.
  • Forecasts almost always presume stability of external systems that the system that holds the forecasted variable is only a part of.  Not that anyone is going to forecast a war between major powers (at present), or a cataclysm greater than the influenza epidemic of 1918 (1-2% of people die), but are users of a forecast going to wholeheartedly believe it, such that if a significant disaster does strike, they are totally bereft?  When is the last time we had a trade war or a payments crisis?  Globalization and the greater division of labor is wonderful, but what happens if it goes backward, or a major nation like France faces a scenario like the PIIGS did?

I leave aside the “surprises”-type documents, which are an interesting parlor game, but have their own excuses built-in.

My advice for you is simple.  Be ready for both bad and good times.  You can’t tell what is going to happen.  Valuations are stretched but not nuts, which justifies a neutral risk posture.  Keep dry powder for adverse situations.

And, from David at the Aleph Blog, have a happy 2017.

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.