Take care with economists’ market forecasts

Another new year is upon us and, as usual, the pundits are busy prognosticating the future. As we repeatedly remind our wealth management clients: Don’t even be tempted to act on these predictions!

You see, year after year, economists consistently get it wrong and only act to confuse investors with their logical sounding economic analysis and forecasts. Bottom line is that for long-term investors, these forecasts amount to nothing more than distractions.

History has proven time and time again that economic market analysis may actually be the cause of below average investing results. Though it seems counter-intuitive that the best economic minds in the country fail in their predictions, regardless of how rational they sound, the numbers tell a different story.

We all know that economists often disagree, yet in an issue of the Wall Street Journal from December 2013, 45 out of 46 economists agreed that interest rates would rise in the coming year. That is a compelling consensus. These experts made a strong case for their forecasts, yet only one economist got it right. The 10-year Treasury bond has not increased, and bonds have actually done surprisingly well!

Professors from North Carolina State University found that economists are directionally correct less than half the time when predicting interest rates. Yet, investors withdrew $170 billion out of bond funds from June to December last year because they believed the pundits.

In 2011, economists predicted that gold would soar in value, as paper currencies were losing value through inflation. At that time, gold was $1,923 per ounce. As of November, this hot commodity was about $1,150 per ounce. Ooops; failed predicting, again!

We all want to believe that someone has definitive answers, but the truth is that the economy is made up of extremely complex and constantly-changing variables, which our brains are not equipped to evaluate. Humans developed the ability to make snap decisions from cues in their environment to ensure their survival, not rational analysis about long-term investments. Human nature fools us into thinking that experts can foresee the future.

The success rate among professional prognosticators was investigated by University of California, Berkeley, Professor Philip E. Tetlock, as reported in his 2005 book Expert Political Judgment. After testing 284 experts in political science, economics, history and journalism in a staggering 82,361 predictions about the fates of scores of countries, the author concluded that they did little better than “a dart-throwing chimpanzee.” Professor Tetlock found that the experts “assigned probabilities of 65 percent to rosy scenarios that materialized only 15 percent of the time.” Doomsters did even worse: “They assigned probabilities of 70 percent to bleak scenarios that materialized only 12 percent of the time.”

Wall Street has always tried to sell Main Street on the idea that experts can consistently time the market and make accurate predictions of when to buy and sell. They can’t. Professional economists for large-scale market indicators can’t reliably call the shots either. As economics Nobel laureate Paul Samuelson long ago noted in a 1966 Newsweek column: “Commentators quote economic studies alleging that market downturns predicted four out of the last five recessions. That is an understatement. Wall Street indexes predicted nine out of the last five recessions!”