Here We Go Again: Forecasting Follies 2016

Forecast 2

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. 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. Continue reading

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A New Kind of Investment Outlook

Outlook212015 Outlook2014-2015

Forecasting Follies

Nobody’s perfect.

That universal truth is easy to prove, of course, and no sane person would deny it. Indeed, even the smartest of us are far from immune even in our areas of expertise when we’re actively trying to do our best. A famous study by the U.S. Institute of Medicine concluded that up to 100,000 people die each year due to readily preventable medical errors. Since physicians are among the smartest and most highly trained professionals imaginable, being stupid is obviously not a prerequisite for making mistakes, even horrible mistakes.

It’s also easy to prove how error-prone we are in the investment world. Every year I take a look at various predictions for the year that’s ending and they are uniformly lousy in the aggregate. Moreover, when somebody does get one right or almost right, that performance quality is not repeated in subsequent years.

2014 provided more of the same in this regard. The median S&P 500 forecast among 50 top-end investment experts called for a year-end level of 1,950, up 6.44 percent on the year. As noted above, the actual closing level was 2,059, up 11.39 percent, essentially five full percentage points higher. That’s a miss of monumental proportions.

Last January, analysts called for far higher oil prices, firmer inflation, a worse jobless rate and higher interest rates. The exact opposite happened in each of those areas. The consensus crude oil price forecast was nearly $95 per barrel (up a bit) and 72 out of 72 economists were anticipating higher interest rates and lower bond prices. Advisor magazine reported that bond market sentiment was utterly bearish, leading pundits to recommend that investors limit their bond holdings to the shortest maturities in 2014. Meanwhile, 30-year U.S. Treasury bonds returned nearly 30 percent. Last April, Peter Schiff of EuroPacific Capital made the bold prediction that the “Federal Reserve’s quantitative-easing program will push gold to $5,000 an ounce.” The shiny yellow metal closed 2014 at just under $1,200, 80 percent or so lower than Schiff’s target.

Alleged experts miss on their forecasts and miss by a lot. Let’s stipulate that these alleged experts are highly educated, vastly experienced, and examine the vagaries of the markets pretty much all day, every day. But it remains a virtual certainty that they will be wrong often and often spectacularly wrong. On account of hindsight bias, we tend to see past events as having been predictable and perhaps inevitable. Accordingly, we think we can extrapolate from them into the future. But the sad fact is that we can’t buy past results. Continue reading

The Halftime Report

Q4“To err is human,” wrote Seneca. “To persist in it is diabolical” (Errare humanum est, Perseverare diabolicum). As 2014 opened, pundits expected interest rates and stocks to go higher, with more certainty about the former than the latter. They also expected the economy finally to turn the corner after five years of sub-par performance. Now that the midway point to the year has been reached and stocks, bonds and commodities have all posted gains together for the first time since 1993, my ongoing and deeply held cynicism about forecasts and forecasters has yet again been confirmed. In other words, be leery about fighting the Fed, fade forecasts and be sure to diversify. Continue reading