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Folly of forecasting and useless data

Never invest on the basis of forecasts. So says James Montier, recently anointed the dean of behavioural finance in the UK. Glance at the index of Value Investing, his superb collection of essays on the subject, and you will find that “forecast” appears more often than any other, with the exception only of the holy of holies, Ben Graham himself. References to the former are as consistently negative as those to the latter are positive.

“The evidence on the folly of forecasting is overwhelming,” Mr Montier concludes, whether you are talking about economists or stockbroking analysts. “Frankly the three blind mice have more credibility than any macro-forecaster at seeing what is coming,” is his verdict on economists. As for analysts, he notes that the average forecasting error in the US analyst community between 2001 and 2006 was 47 per cent over 12 months and 93 per cent over 24 months. 

And what does Ben Graham say? “Forecasting security prices is not properly a part of security analysis”. Judging by the response to my last column, which described John Templeton’s approach to the forecasting business, this is a view that many participants in the securities business share. The only professionally acceptable response to any question on the subject of analyst reports is to say: “Well, I read them – but only for the data, you understand, not for the recommendations.”

The only problem with all this is that it does not seem to be true. It would be nice to meet a few professional investors who do not in practice rely quite heavily on forecasts to inform and justify their investment views. This has prompted me over the years to formulate some other rules I have found helpful in distinguishing between useful and useless research.
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