Here We Go Again: Forecasting Follies 2016

Image from xkcd

In a great scene from the classic film, The Wizard of Oz, Dorothy and her friends have — after some difficulty and fanfare — obtained an audience with “the great and powerful Oz.” When, during that audience, Dorothy’s dog Toto pulls back a curtain to reveal that Oz is nothing like what he purports to be, Oz bellows, “Pay no attention to that man behind the curtain,” in an unsuccessful effort to get his guests to focus their attention elsewhere.

Like the Wizard, the great and powerful on Wall Street would have us pay no attention what is really there — “behind the curtain.”  Yet once in a great while the Street rats itself out so that we get to find out, beyond a shadow of doubt (if you still had any), what the big investment houses really think about what they do and who they do it to.

The now-defunct Bear Stearns won a noteworthy 2002 legal decision involving former Fed Governor and then-Bear Chief Economist Wayne Angell over advice he and the firm gave to a Bear Stearns client named Count Henryk de Kwiatkowski (really) after the Count lost hundreds of millions of dollars in a just a few weeks (really) following that advice by trading currency futures on margin (really). The Count had been born in Poland, escaped invading Nazis, been banished to Siberia by the Soviets, escaped and travelled across Asia on foot to Tehran, talked his way into the British Embassy, became a renowned RAF pilot, moved to Canada, became an engineer, and made a fortune trading used airliners, most famously selling nine 747s to the Shah of Iran over a game of backgammon in the royal palace (really). He also became the owner of the famous thoroughbred racing institution, Calumet Farm (really).

Bear offered the Count “a level of service and investment timing comparable to that which [Bear] offer[ed its] largest institutional clients” (which is not to say that they were any good at it). The key trade was a huge and ultimately disastrous bet that the U.S. dollar would rise in late 1994 and early 1995. At one point, the Count’s positions totaled $6.5 billion nominally and accounted for 30 percent of the total open interest in certain currencies on the Chicago Mercantile Exchange. The jury awarded a huge verdict to the Count but the appellate court reversed. The appellate judges determined, quite conventionally, that brokers may not be held liable for honest opinions that turn out to be wrong when providing advice on non-discretionary accounts.

But I’m not primarily interested in the main story. Instead, I’m struck by a line of testimony offered at trial by then-Bear CEO Jimmy Cayne that does not even show up in subsequent court opinions, despite extensive recitals of the facts of the case. The generally “cocksure” Cayne apparently thought that his firm could be in trouble so he took a creative and disarmingly honest position given how aggressive Bear was in promoting Angell’s alleged expertise to its customers. Cayne brazenly asserted that Angell was merely an “entertainer” whose advice should never give rise to liability.

Advertisement

Doing Too Much

It was the worst moment in San Diego Chargers history, even worse than drafting Ryan Leaf (who, coincidentally, was released from prison this week).

On January 14, 2007 I was in the stands with my younger son watching as the Chargers (14-2 in the regular season and widely regarded as the league’s nest team) hosted the New England Patriots in the divisional round of the playoffs. The Chargers had been 8-0 at home, had five All-Pro players and had nine players elected to the Pro Bowl. The day before I had received a certified letter from the Bolts, advising me that I had won a lottery among season tickets holders and would thus be allowed to purchase Super Bowl tickets if (when!) the Chargers advanced there.

But the day didn’t turn out the way I had envisioned.

Marty Schottenheimer foolishly attempted to convert a 4^th and 11 at the New England 30 early in the game. The sure-handed Eric Parker muffed a punt, one of four turnovers in all. Drayton Florence head-butted a Patriots player and drew an unsportsmanlike conduct penalty to negate a fumble recovery for the home team. Lots went wrong, but the Chargers still had the lead late. The great LaDainian Tomlinson, who had rushed for 1,815 yards and 31 touchdowns that season, ran for 123 yards and two scores that afternoon and extended the lead to 21-13 via a touchdown run with 8:35 left in the 4^th quarter.

On the very next series, Tom Brady threw his third pick of the day. The game should have been over, but Marlon McCree tried to return the interception rather than falling to the ground while cradling the football. McCree was stripped of the ball (right); the Patriots recovered and went on to win. When the Pats proceeded to do the silly Shawne Merriman sack dance on the Chargers logo in the middle of the field after the game, it instigated a brawl.

After the game, McCree was unrepentant. “I was trying to make a play,” he said, “and anytime I get the ball I am going to try and score. …[In] hindsight I don’t regret it because I would never try and just go down on the [ground]. I want to score.”

It’s a football cliché, of course, but Marlon McCree simply tried to do too much. It happens in investing all the time too.

Kobayashi Maru and the Forecasting Follies

In the Star Trek universe, the Kobayashi Maru is a Starfleet Academy training exercise for future officers in the command track. It takes place on a replica of a starship bridge with the test-taker as captain. In the exercise, the cadet and crew receive a distress signal advising that the freighter Kobayashi Maru has stranded in the Klingon Neutral Zone and is rapidly losing power, hull integrity and life support.

The cadet is seemingly faced with a decision (a) to attempt to rescue the freighter’s crew and passengers, which involves violating the Neutral Zone and potentially provoking the Klingons into an all-out war; or (b) to abandon the ship, potentially preventing war but leaving the freighter’s crew and passengers to die. As the simulation is played out, both possibilities are set up to end badly. Either both the starship and the freighter are destroyed by the Klingons or the starship is forced to wait and watch as everyone on the Kobayashi Maru dies an agonizing death.

The objective of the test is not for the cadet to outsmart or outfight the Klingons but rather to examine the cadet’s reaction to a no-win situation. It is ultimately designed as a test of discipline and character under stress.

However, before his third attempt at the test while a student, James T. Kirk surreptitiously reprograms the simulator so that it was possible to rescue the freighter.

Optimism Bias at Work

ESPN has 32 team bloggers, and each has predicted the 2014 season record for the team he or she (they aren’t all guys) covers. They are remarkably positive on the chances for each team next season, forecasting that, in the aggregate, NFL teams will win far more games than they lose, quite impossibly going 290-222 (as reported by The Big Lead). Again. Last year, also as reported by The Big Lead, they collectively predicted that NFL teams would go 283-229.

It’s easy to assume that we’re witnessing the collective math or probability suckage that so easily beset us. But that would be an erroneous conclusion since ESPN is careful to inform us that each team’s blogger made his or her prediction independently and only made a guess as to his or her covered team. Instead, what we’re seeing is an obvious example of how bad we are at forecasting and how susceptible we are to optimism bias. In general, it’s a lot more fun — and you get a lot more readers — when covering a winning rather than a losing team).

Remarkably, only five teams are forecast as having a losing record this year, with Washington (at 7-9) the only sub-.500 team in the entire NFC. Three teams in the powerful NFC West are expected to go 12-4. My Chargers are even expected to go 10-6 (don’t we wish). But at least the blogger for the Cowboys seems to have (finally?!) learned his lesson as what was once America’s Team is predicted to go 8-8 (yet again). And, happily, the hated Raiders are said to be a 5-11 team. There’s at least some reality-based thinking going on at ESPN!

Fans are well-known to be excessively optimistic in general and especially so before the season begins. It seems clear, yet again, that the alleged “experts” are too.

More Probability Suckage

Source: xkcd

I have often noted (see here too) that we generally suck at math, to our great detriment. I have also noted that we are especially poor at dealing with probabilities. If a weather forecaster says that there is an 80 percent chance of rain and it remains sunny, instead of waiting to see if, in the aggregate, it rains 80 percent of the times when his or her forecast called for an 80 percent chance of rain, we race to conclude — perhaps based upon that single instance — that the forecaster isn’t any good. Data trumps our lyin’ eyes, but we don’t routinely see it (and even deny its efficacy).

Further evidence – as if it were needed – in support of my thesis has been offered this week in the reaction to Nate Silver’s projection that Republicans have a very real chance of gaining control of the Senate later this year. This forecast (“a Republican gain of six seats, plus or minus five”) is hardy earth-shattering to anybody who has been paying attention. The configuration of seats up for election favors Republicans and the Democratic President’s approval ratings are dreadful. There isn’t much reason to expect an upswing in Democratic support either, even though (obviously) almost anything could happen over the next few months. Dealing with probabilities necessarily means being wrong sometimes.

Big Buy Signal

Now marketing himself as a “rogue economist,” Harry Dent is forecasting “gold down to $750 an ounce, housing down 35%, oil down to $10 a barrel, the Dow down to 6,000, [and] a war between inflation and deflation” this year. The headline is indeed shocking:

If Only HALF of Harry’s Forecasts Come

to Pass, the American Life We Know Will

Disappear for Good!

So is the headline immediately above (from his personal website — the brazen self-promotion is shocking too).

Of course, Harry can show you how to avoid and even profit from this impending catastrophe. Amazing. More importantly, unlike most of his ilk, Harry has perhaps offered something actionable, if not in the way he intended. You don’t even need to buy anything to learn what to do.

 Let me explain.

50 Years Ago Last Night

On February 9, 1964, The Beatles, the greatest rock-n-roll band of all-time, made their first American television appearance on The Ed Sullivan Show, opening with All My Lovin’ and following up withThere Was You and She Loves You. They later closed the show with I Saw Her Standing There and I Want to Hold Your Hand. The British Invasion had begun.

 

 

A then-record 73 million people tuned in (over 45 percent of American households, nearly identical to the rating this year’s record-setting Super Bowl achieved),making it one of the seminal moments in television history. Now, 50 years later, people still remember exactly where they were that night (I was in church).

Exhibit A

I have often warned against making investment decisions based upon political commitments, and I am hardly alone. A wonderful/dreadful example is provided by Stephen Moore, who announced this week that he is leaving The Wall Street Journal to become Chief Economist for the Heritage Foundation. Quite obviously, Moore opposes the policies of President Obama vociferously (“Everything he’s done has been such a massive failure…”).

That is his right, of course, and I take pains to keep Above the Market away from politics as much as possible. My point is that Moore’s political commitments foolishly override more objective analysis and thus impact his economic and investment outlooks negatively.

Missed It By *This* Much

It’s part of the gig. A Wall Street strategist, economist or even a run-of-the-mill investment manager gets a crack on financial television and is asked about his or her forecast for the market. Instead of wisely objecting to the premise of the question, the poor schlemiel answers and, once matters play out, is shown to have been less than prescient (even though the forecast is likely forgotten). Indeed, one forecast that is almost certain to be correct is that market forecasts are almost certain to be wrong.

The delightful old Mel Brooks/Buck Henry spy satire Get Smart, which was on television from 1965-70, included a number of funny catch-phrases uttered by Don Adams as agent Maxwell Smart (played by Steve Carell in the movie). One of them was the following, offered when Max had, yet again and like our fearless forecasters, screwed up.

So, as year-end approaches, let’s take a look at how much “this much” is — how badly various Wall Street market forecasts missed it with their prognostications for the S&P 500 in 2013.

Something Wicked This Way Comes

As my firm’s Chief Investment Officer, it’s my role (among other things) to provide thought leadership for the organization and its representatives – to outline and explain best practices and approaches with respect to the markets and investing.  Most fundamentally, if metaphorically, my job means standing up and pointing in the right direction.

I have been thinking a lot lately about how to do that more effectively, and the issue was highlighted for me anew yesterday during the outstanding Big Picture Conference here in New York City, hosted by Barry Ritholtz and Josh Brown. As part of the conference, Josh hosted a panel of Chief Investment Strategists: Dan Greenhaus of BTIG, Art Hogan of Lazard and Jeff Kleintop of LPL. All three were intelligent, engaging and very well-informed. Dan’s bio says he “is charged with evaluating both domestic and global macro trends as well as formulating top down investment strategies for clients.” That’s consistent with the way the role is typically conceived. As he put it on the panel, his job is to tell his clients what’s going to happen next. Of course, strategists do what they do for a much wider audience than that, as all are providing opinions regularly across media platforms, including television and radio financial news. They’re out to build their firm’s brand, and their own brand too.

Josh led the three of them on a brisk tour of the world markets.  They talked about macro risks and opportunities – what they think the immediate future has in store. And they were very good at it, impressively weaving together stories, themes and data into a powerful package of possibilities. It was wonderfully entertaining and even plausible. Some bits of it may even turn out to be accurate.

But my thumbs kept twitching (“pricking” in the Bard’s turn of phrase) throughout. Josh hinted at the inherent problem with the approach each took, suggesting that such moment-by-moment commentary and reaction is effectively meaningless.  I’d take Josh’s point one step further and call it wicked.