Why forecasts do not help

Financial media consists largely of forecasts, and the record of forecasting is the most consistently ignored evidence in the field.

What the record shows

Across several categories.

Studies of professional economic forecasters have repeatedly found poor accuracy in predicting recessions, particularly turning points, which is when a forecast would be most valuable.

Analysts' earnings forecasts have systematic biases and limited accuracy beyond short horizons.

Strategists' year-ahead market targets cluster around modest positive returns regardless of what subsequently happens, and their dispersion rarely includes the actual outcome in extreme years.

And research on expert political and economic judgement more broadly has found that experts perform little better than simple statistical rules, and that confident experts perform worse than tentative ones.

Why forecasting is hard here

Structural reasons.

Prices already incorporate widely available information and expectations, which means only surprises move them — and surprises are by definition not forecastable.

The system is reflexive: forecasts influence behaviour, which influences outcomes.

Outcomes depend on politics, technology, conflict and weather as well as economics.

And the distribution of outcomes includes rare, large events that dominate long-run results and are essentially unpredictable.

Why forecasts persist

Despite the record.

Demand: people find uncertainty uncomfortable and want a view.

Media requires content, and a forecast is content.

Accountability is weak: forecasts are rarely scored systematically, and forecasters are rarely judged on their record.

Incentives favour boldness, since a correct dramatic call builds a reputation and an incorrect one is forgotten.

And hindsight bias makes past events appear more predictable than they were, which sustains the belief that prediction is possible.

What acting on forecasts costs

The practical harm.

Moving in and out of markets based on forecasts incurs transaction costs and tax.

It requires being right twice — when to exit and when to re-enter — and the second is generally harder.

It risks missing the strongest recovery days, which cluster around the worst days.

And it converts a passive plan into a series of active decisions, each of which can be wrong.

The behaviour gap discussed elsewhere on this site is largely the aggregate of people acting on views about the near future.

What to do instead

Since uncertainty is genuine.

Build a portfolio that does not require a forecast to be correct: diversified across assets, geographies and companies.

Set an allocation based on your horizon and capacity for loss rather than on a view about the next year.

Rebalance on a rule rather than a judgement.

Hold cash for short-term needs, which removes the need to predict.

Contribute regularly regardless of the level of the market.

And accept that the correct response to genuine uncertainty is robustness rather than prediction.

The forecasts that are useful

Some things are more predictable than others.

Costs, which are known in advance.

Tax treatment, largely.

Your own contribution rate.

Your own time horizon.

The mathematical relationship between contributions, returns and time.

And the range of historical outcomes, which is not a forecast and is a useful indication of what to plan for.

Concentrating on the controllable variables is the practical alternative to forecasting.

Reading commentary usefully

If you read it at all.

Note whether the writer has a position and an incentive.

Note whether previous forecasts are ever revisited.

Prefer analysis of what has happened and why to prediction of what will.

Prefer base rates and long-run evidence to narratives about the current moment.

And treat confident specific predictions with more scepticism than uncertain general ones, which is the opposite of how they are usually received.

The humility that follows

Worth stating.

Nobody knows what markets will do next year, including people who say they do and people who are paid a great deal to have a view.

Which is not a counsel of despair — it is the basis of an approach that does not require knowing.

And an investor who accepts this is considerably less likely to make the decisions that produce the behaviour gap.

General information only, not investment advice. Investments can fall in value and past performance does not indicate future returns. Consult a regulated financial adviser.