Nothing Changes on New Year’s Day

There is something about the beginning of a new calendar year that seems to induce some slightly odd behaviour amongst some people. I’m not just thinking about all the new years’ resolutions to go the gym or cut down alcohol.

What’s odd is the continued desire to make financial market and economic forecasts. They are everywhere – newspapers, websites, emails all contain them. Then there are the conferences, webinars and lunches.

Why do we listen?

We have written before about the problems with forecasting on the blog. It is hard not to sound like a broken record: humans are not very good at predicting the future of anything: financial markets, political events or the weather. We all know this but just like clockwork, continue to play the game every time January rolls around.

There are a range of forecasts for 2016, and also forecasts for surprises for 2016. They cover all asset classes, economies and world events. Buttonwood in the Economist for example suggests that the surprises for 2016 might include a weaker dollar, higher bond yields, Brexit, a weak pound and emerging market out-performance.

How well did forecasters do last year?

A year ago, investors were expecting (amongst other things) rising equity markets, rising bond yields, a 50% chance of Greece being forced out of the Euro (a subject that Stuart wrote about on the blog in May 2015), and that the outcome of the UK general election will be a hung parliament.  How did they do? Well Greece stayed in the Eurozone and the Conservative Party won the UK election. Equity market returns are shown in the table below.

JR NY blog1

Many equity markets had a decent start to the year but then moved sideways through the summer and fell back from August onwards. German and Italian equities are examples of this pattern. This means there is scope for both positive and negative camps to claim that they were right for part of the year! We often reinvent history in this way to make us feel good about ourselves. It’s called hindsight bias, and it is part of the reason that humans often fail to learn from their mistakes.

Similarly within the bond universe there was a mixed bag. Fed lift-off was meant to be the event of 2015 but while some yields rose significantly (like Brazil), others barely moved at all. Much forecasting is so much wasted effort.

JR NY blog2

Are we doomed to repeat our mistakes? Perhaps not…

Glenn Stevens, Governor of the Reserve Bank of Australia talked about forecasting in a recent speech  in which he concludes that “human nature won’t change. That means that we, as human beings, will be irresistibly drawn to those who claim to be able to forecast the future, beat the market, and give us the illusion of certainty and control”.

However, we may not need to be so pessimistic. Interesting work is being done to make our forecasts smarter.

Some hope

Philip Tetlock, who was once quoted as saying that “the average expert was roughly as accurate as a dart-throwing chimpanzee,” now believes that successful forecasting is possible.

In his new book he explains that some people do have above average forecasting talent – they are “Superforecasters”. And even more encouraging is his conclusion that “Superteams” perform better than individuals. Superteams support and challenge each other, and avoid the risk of group-think.

What matters is our ability to learn from our mistakes and avoid the emotional temptation to reinvent history. Superforecasters are able to do this naturally, for the rest of us ‘superteams’ can provide objective feedback on how successful our predictions actually were. Tim Harford summarizes the lessons we can learn extremely well:

So there are steps we can all take to improve our decision making. As Harford suggests, this is challenging, and certainly less fun than making predictions themselves. But this is one New Year’s resolution that is definitely worth making

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.