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Abraham Okusanya: Treat investment forecasts as entertainment not gospel

It is that time again where clairvoyants in the investment industry fall over themselves to file their predictions for markets in the year ahead.

Analysts will pontificate on everything from the global economy and political stability to interest rates. They will aim to convince us equity valuations are stretched and the only way to avoid the impending Armageddon is – you guessed it – to invest with them.

A quick revision of outlooks issued by asset managers at the start of last year will show just how horribly wrong most turned out to be. Very few accurately predicted a double-digit return for UK, US, European and emerging market equities in a supposedly “low return” world.

Even fewer predicted a positive return for virtually all mainstream asset classes. For the tiny minority who did, I will wager that luck rather than skill played a vital role in the outcome. After all, even a broken clock is right twice a day.

Chinese poet Lao Tzu wisely observed that those who have knowledge, do not predict. Those who predict, do not have knowledge. I often wonder why many forecasters have not given up on this incredibly futile exercise. If most are always wrong, why do the poor souls keep making them?

The answer lies in the fact the relevance and livelihood of forecasters depends not on the accuracy or usefulness of their predictions, but simply in making them. As psychology professor Philip Tetlock noted, old forecasts are like old news — soon forgotten — and pundits are almost never asked to reconcile what they said with what happened.

Some argue forecasts do not have to be accurate per se, but that we need something to hang our hat on to make decisions. I disagree.

So, how do we make investment decisions in the absence of a forecast? For this, we turn to George Savile, the first Marquess of Halifax, who observed that “the best qualification of a prophet is to have a good memory”.

Long historical data provides a good understanding of the behaviour of major asset classes. Over the last 100 years, global equities have produced a real return of 7 per cent per annum on average. That is higher than bonds, gold, property and cash.

Never mind the period in question included two World Wars, the Great Depression, several recessions and innumerable political unrests across the world. Of course, returns vary significantly from year to year, with the highest annual return of 55 per cent to the lowest of -31.4 per cent.

Clearly, current high equity valuations indicate a higher probability that long-term return would be lower than the historical average. But predicting a specific figure is nothing more than crystal ball gazing.

Accordingly, most economic forecasts based on near-term movements of asset classes are nothing but a meaningless distraction for long-term investors. Not only that, they tend to encourage poor market-timing behaviour that results in permanent loss of wealth.

If I did not know any better, I would appeal to asset managers to stop issuing market forecasts, or at least acknowledge they are best treated as entertainment. But that is not going to happen, is it? So, the onus is on investors and advisers to just ignore them.

Abraham Okusanya is director of Finalytiq

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Comments

There are 3 comments at the moment, we would love to hear your opinion too.

  1. I predict a riot…

  2. To quote Niels Bohr, “Predicting very difficult, especially about the future” and economists are people who will tell you exactly what will happen and will be able to tell you afterward exactly why it didn’t.

  3. Great article. There have been some amazing predicitions from various investment managers this season. Would love to understand the rationale of how these claims can be substantiated.

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