It\’s been a fascinating past fourteen days with the New Democratic Party winning the Alberta election, the Calgary Flames getting eliminated in the playoffs and I ruptured my Calf msucles at a father-son pickup the game of basketball.
The one thing the 3 events have in common is that Never imagined any of them would happen.
Perhaps there is a valuable lesson here in that forecasting is really a futile exercise that only provides a temporary, but quickly fleeting sense of comfort that everything is going to be peaches and cream much more reality it sometimes dishes out a plate of liver and onions.
That said, forecasting goes on all the time, especially when it comes to investing. There is no shortage of so-called experts predicting from future earnings to the direction of equities, bonds and markets.
The problem is that the experts are terrible at it.
For example, take a look at the largest, longest study of expert economic forecasts performed by Philip Tetlock, a professor in the Haas Business School in the University of California-Berkeley, and highlighted within the book The sun and rain of Investing by Charles Ellis.
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The study included a review of 82,000 predictions over 25 years by 300 selected experts and concluded that these predictions barely beat random guesses. Ironically, the more famous the expert, the less accurate his or her predictions were rather.
This is evident within the abysmal track record of analyst predictions of U.S. corporate earnings.
At the start of the year, the typical analyst forecast called for a year-over-year EPS rate of growth of 4.3 percent in Q1 for S&P 500 companies, which is much higher than the realized 0.1 per cent – the cheapest growth rate since Q3 2012.
Analysts sneakily reduced their estimates lower throughout the quarter, and ultimately were with a 4.7-per-cent drop – the largest percentage point decline in expectations since Q1 2009. Remember that the next time you hear a pundit touting that 71 per cent of those reported have beaten analysts\’ earnings expectations.
Overall, we think an investor\’s time is much better spent identifying the risks, determining if they\’re factored in the present market or not, and then managing them accordingly.
For example, just before election night in Alberta, oil producers located in the province were discounting a near zero possibility of an NDP win within their share prices even though the polls were indicating a high probability that the NDP would form a majority government.
Perhaps it had been because most of the experts, including energy fund managers, were making their own predictions, touting the possible lack of relevance of polling, there would be little chance of an NDP win.
They confidently shrugged from the significant risks to Alberta’s energy sector from a NDP platform that clearly included a corporate tax hike, royalty review and new environmental policy.
All of the is not good news for those investors who paid attention to those experts as, depending on their positions, they\’ve since lost anywhere from five to twenty per cent.
Since these stocks didn’t sell ahead of election night, it made a lot of sense to proactively trim it well or undertake some hedging from the risk of an NDP win. If the party didn’t win, as many were predicting, those positions could have have easily been bought back at or near the same levels.
In conclusion, if you still want to listen to all of the pundits predicting the future, make sure to heed Tetlock’s recommendation to pay more focus on those who bore you having a cloud of \”howevers\” than those overly confident, charismatic pros who have a great story to tell.
Martin Pelletier, CFA, is a portfolio manager at Calgary-based TriVest Wealth Counsel Ltd.