Improving Investor Behavior: Forecasting is an illusion of knowledge

Have you ever tried shaking one of those magic eight balls found in the toy aisle? You know the gist: Ask a random but important question like, “Will the Broncos win the Super Bowl this year?” Then get a generic answer like, “Ask again tomorrow.” And finally in frustration, ask the same question and vigorously shake until you get the answer you’re hoping for: “Without a doubt.”

This is similar to cracking open a fortune cookie and hoping to find meaning in the random answer to a random question. Yet 99% of the time, the cookie’s answer isn’t relevant let alone one we believe to be true. But this idea that we can accurately peek into the future and gain crucial insight keeps us wanting more.

Forecasting financial markets is no different. I’m not saying the media pundits on CNBC have a magic eight ball behind their desks. But honestly if they did, would we evaluate these “experts” any differently? “Today we’re discussing stock XYZ. According to our analysts, this stock’s outlook is — (shakes ball behind desk) — not so good. More news at eight.” Pundits believe they can see into the future, and they convince their viewers of the same. As a result, forecasting becomes a believable art.

Over time, I’ve learned to be on guard when hearing economic forecasts. They never seem to predict the future with any accuracy. As Canadian-American economist and diplomat John Kenneth Galbraith has said, “There are really two kinds of forecasters; those who don’t know, and those who don’t know they don’t know.”

Forecasting isn’t new. Even back in biblical times, dream interpreters and fortune tellers were held in high esteem and earnestly sought. But as much as we may long for a predictable future, there’s only one thing we can count on: There are no facts about the future.

Even broad generalizations about the future tend to miss the mark. Let’s look back to January 2023 and revisit some of these predictions.

• A recession is coming soon. A recession, whether traditional or newly defined, simply hasn’t happened. And “soon” is a nebulous word. Indeed, a recession will occur given a long enough time horizon. When it does, these same forecasters will stand up and say, “See, we were right all along!” Never mind that they’ve called 14 of the last three bear markets, and 11 of those predictions never occurred. Instead, the economy today is seemingly more resilient than the consensus about it was just nine months ago.

• Corporate earnings will collapse. Not long ago, forecasters were calling for a collapse in corporate earnings. The recent data shows earnings down a bit, but far from a “collapsed” level. Also absent are any corporate defaults that were predicted.

• The U.S. dollar will collapse. The dollar is close to its level from a year ago. No significant weakness has been found (yet). What currency do you think the world trusts? Bitcoin? The Chinese yuan? The euro? Amazingly, 80% of all U.S. $100 bills, and nearly 60% of all paper U.S. currency, exists outside the United States, according to the International Monetary Fund.

• The banking system will collapse. Recall the fear that the collapse of Silicon Valley Bank would cause a contagion, leading to the destruction of banks on par with 2008 and 2009? Yet today, most banks seem pretty stable. Those that improperly invested their reserves in long-term treasury bonds to earn a paltry interest on their capital when interest rates were near zero are struggling, but that’s due more to poor management than poor economics.

• Rising inflation will destroy consumer demand. In spite of continued increases in inflation, the consumer has remained surprisingly resilient, adapting their spending to increased costs in nearly every purchase. Inflation has moderated somewhat, but the ultimate outcome of inflation (and of the Federal Reserve tightening) remains to be seen. To date, consumers are still buying stuff — which is a good sign.

The lesson here is simple: The end of the world has a funny way of getting postponed. Since no one can see the unseen, great investors must remain humble.

These forecasts leave two options in how to respond. First, panic and react, or second, take a deep breath and calmly remind yourself that this too shall pass. Like an airplane passenger experiencing turbulence, the right course of action is rarely to jump up and attempt to commandeer control from the pilot. Use discipline to withstand the inevitable yet temporary price declines. These dips may feel uncomfortable, but ultimately they provide potential opportunities to arrive at your desired destination by acquiring great businesses at lower prices.