New Year begins with usual predictions about “pick of the year”, “budget expectations” and “Sensex/Nifty target at the end of the year”. We investors should spend no time on this activity. Howard Marks wrote about value of predictions in the investment world. He starts by saying that he agrees with John Kenneth Galbraith. He said “We have two classes of forecasters: Those who don’t know — and those who don’t know they don’t know.” If it was easy to predict the future, it would be easier to attain excellent investment results — then maybe everyone could have above-average performance.
Being Right With Average Consistency Doesn’t Help: Let’s face it: most of us have roughly the same ability to predict the future. And the trouble is that being right as often as the average forecaster won’t produce superior results. Every investor wants results which are above average. In the institutional world, relative performance is the Holy Grail. Even elsewhere, the objective is to be the first to see the future — and take the appropriate route to profit. It obviously doesn’t help in these pursuits to be right only as often as others are.
At least twenty-five years ago, it was noted that stock price movements were highly correlated with changes in earnings. So people concluded that accurate forecasts of earnings were the key to making money in stocks. It has since been realized, however, that it’s not earnings changes that cause stock price changes, but earnings changes which come as a surprise.
This raises an important Catch 22. Everyone’s forecasts are, on average, consensus forecasts. If your prediction is consensus too, it won’t produce above-average performance even if it’s right. Superior performance comes from accurate non-consensus forecasts. But because most forecasters aren’t terrible, the actual results fall near the consensus most of the time — and non-consensus forecasts are usually wrong. The problem is that extraordinary performance comes only from correct non-consensus forecasts, but non-consensus forecasts are hard to make, hard to make correctly and hard to act on.
Most Forecasts are Extrapolations: The fact is, most forecasters predict a future quite like the recent past. One reason is that things generally continue as they have been; major changes don’t occur very often.
Forecasters are Usually Most Wrong at the Extremes: It’s at just such times — such inflection points — when accurate forecasts of change would be the most valuable but are the hardest to make.
The more a prediction of the future differs from the present, (1) the more likely it is to diverge from the consensus forecast, (2) the greater the profit would be if it’s right, and (3) the harder it will be to believe and act on it.
Not only must a profitable forecast have the event or direction right, but it must be correct as too timing as well. In investing, it’s hard to hold fast to an improbable, non-consensus forecast and do the right thing…especially if the clock is telling you the forecast is off base. Marks was told years ago, “being too far ahead of your time is indistinguishable from being wrong.”
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