“Economists predict not because they know, but because they are asked.” So said John Kenneth Galbraith, himself an economist.
A recent Wall Street Journal article shows one way the shrewd, career-preserving forecaster hedges his bets. He’ll say that an event, such as a recession or bear market, has a 40% chance of occurring. If the event occurs, he can take credit for having seen its strong possibility. If it doesn’t happen – well, the odds were always against it.
This is just one of the tricks of a very old trade. A brokerage I knew used to employ a “market technician” – a sort of shaman or witch-doctor, really, though one with a college degree – who used to analyze what he supposed to be short, medium and long-term cycles in the stock market.
This fellow had visions of the likely course for each cycle, and grateful listeners paid trade commissions to his employer for the privilege of hearing him. If stocks fell, that was said to confirm his medium-term forecast. If they rose, that was due to a long-term uptrend he had predicted. His descriptions of waves and cycles made me seasick, but he was employed for many years, so he must have provided what his listeners wanted.
Accuracy Not Required
Someone new to forecasting might find it a nerve-wracking job. “How do I make an accurate forecast when so much can’t be predicted?” Fortunately, accuracy is not high on the list of job requirements. The most important thing is to provide the listener with support for what he already wants to do.
How “sophisticated” a prediction should look will vary. A palm-reader can trace lines in a person’s hand and tell the customer in a few words what he or she wants to hear. A consultant hired by the city council to determine whether a new arena will be able to break-even will need to produce a report at least half-an-inch thick with figures taken out to two decimal places.
Yes, but . . .
But don’t we as investment managers make predictions? Is it right for us to poke fun at others?
Yes. And yes.
We try to make rational, conservative estimates about the future. We don’t simply assume that existing conditions, good or bad, will continue indefinitely.
When we find a company we like at a market price below our estimate of value, we can buy with a margin of safety. This provides an opportunity for gain as the market price rises – we hope – to our estimated value, but it also affords some protection against disappointments.
Our approach tries to take advantage of the overconfidence that others have in their forecasts. A stock becomes cheap, after all, when other investors are convinced that the outlook is poor. If the future is poor, the stock may not have much downside. If the future is better than expected, the stock may rise. Similarly, if other investors see a brighter future than we do for a stock we own, we can sell to them and look for other investments.
Barry Dunaway, CFA®
Executive Vice President & Director of Research
America First Investment Advisors, LLC
This post expresses the views of the author as of the date of publication. America First Investment Advisors has no obligation to update the information in it. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.