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It’s that time of the year when pundits are out in full force with their predictions for the year ahead. But how much attention do they deserve?
As the events of 2022 reminded us, the world is a big, complicated place with lots of moving parts. It reminds me of what my colleague, portfolio manager Geoff Castle says: “Making predictions is like writing future comedy.”
Who expected the rout in technology stocks? Companies previously thought to be unassailable such as Amazon.com Inc. AMZN-Q, Meta Platforms Inc. META-Q, Nvidia Corp. NVDA-Q and Alphabet Inc. GOOGL-Q took it on the chin, losing a third or more of their market value last year and the tech-heavy Nasdaq 100 Index dropped more than 32 per cent, erasing about US$5.6-trillion in wealth.
Who saw the return of inflation? After several decades of dovish central bank policy, the worm turned last year as central banks raised interest rates aggressively to control inflation, thus hurting consumers, businesses, and asset prices.
Did anyone anticipate Russia’s invasion of Ukraine to endure so long and inflict so much humanitarian damage – in addition to the global price shocks, supply chain disruptions and food shortages?
Since antiquity, humans have sought out oracles who could foretell the future through various methods of divination. In ancient times, that included reading shapes in the sand, interpreting reflections in the water, and decoding grains of corn. In modern times, we have data sets, not tea leaves. Nevertheless, the rates of success among our contemporary oracles – also known as economists and market watchers – are consistently unimpressive.
One of the most comprehensive reviews on the performance of economic forecasters was conducted for the National Bureau of Economic Research in 1982. The study reviewed more than 70 forecasting organizations and their predictions for inflation, real growth, unemployment rates, nominal gross domestic product, consumer expenditures and changes in business inventories since 1968.
The conclusion? Individual predictions were spotty, albeit with occasional moments of high accuracy. As a group, prediction accuracy improved while individual performance was unreliable.
Another Bloomberg LP study looked at 23 years of data on Wall Street consensus in January for the S&P 500 index at the end of December. The guesses were poor, especially during years of economic uncertainty such as 2001, 2002, 2008, and 2022.
Behavioural bias – what is illusionary of control?
Given how unreliable expert predictions are, why do we pay attention to them?
One explanation is that pundits who make big, bold statements pull focus. They’re the ones in the media spotlight who grab the viewers’ attention. A year later, no one remembers what was said and whether it was accurate. No apologies are made.
Also, let’s be honest, we humans are a lazy bunch. If a statement is made often enough and we hear it from a variety of sources, we’re likely to take it as fact without going further to confirm the information.
We do this because it takes less brain processing power to simply accept the general opinion. Conserving energy was an evolutionary advantage, but there’s no free lunch. Sometimes, mental shortcuts come with unexpected costs.
This behavioural bias to accept frequently heard opinions as fact is called illusory of control. The constant barrage of opinionators, prognosticators, and pundits is a form of information overload, or some might say information pollution. We’re busy people. We get tired. When we’re relentlessly exposed to too much information, we just can’t cope. So, we reach for shortcuts to help us get through the day.
There’s nothing wrong with taking the fast and easy way. But if we pay too much mind to predictions that are likely no better than estimates, extrapolations, or guesswork, and if that leads us to make decisions based on the illusory of control bias, that could harm us as investors.
‘Broken’ crystal ball
How can we protect ourselves from the annual parade of pundits?
Turning off the news is not an option, although turning off notifications from time to time is a form of good mental hygiene. There are three things we could all do to be less susceptible to the illusory of control bias:
1. Understand the sources of information we do consume better.
2. Be more mindful about not reading or listening to the news when we’re too distracted or multi-tasking.
3. Remind ourselves of most pundits’ fair to middling performance.
No shade, though. The world is a complicated place with lots of moving parts, which makes it very hard to make reliable predictions. My crystal ball is broken. So is everyone else’s.
This January, by all means enjoy the “future comedy” of pundits, but maybe take their pronouncements with a grain of salt.
Felix Narhi is chief investment officer and portfolio manager at PenderFund Capital Management Ltd. in Vancouver.
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