By Peter Fraser –
Consider the following two comments:
“Virgo: As Saturn transits through your sign, your prime interest today will be coping with occasional fits of sadness. You should be able to cope with any little problems that come your way. Yellow is your lucky colour.”
“We fully expect the FTSE (news) 100 to end the year below the 4600 level. Higher oil prices will feed into broader commodity costs and hence inflation. Central banks will look to raise rates and squeeze corporate margins. Moreover, greater awareness of the ‘time diversification’ effect amongst key investors will diminish the historically high equity premium.”
One of these comments is happy to make vague predictions, based on questionable assumptions, but has a fair chance of being proved correct. The other is a horoscope.
Most of us like experts – ‘when in doubt, contract it out’- however, in finance this is problematic.
In the first instance, the subject itself can be simply too complex, especially as you start to stray from the particular to the general. Your assumptions about interest rates may be undermined by a natural disaster; your forecasts on productivity annihilated by a new invention. Just as the notorious ‘butterfly effect’ (“Does the flap of a butterfly’s wings in Brazil set off a tornado in Texas?”) is inherent in weather prediction, so too it seems a fair assumption that long term general economic forecasting is a forlorn hope.
Secondly, many people are convinced that those who work in the City are privy to secret information that can make you rich. When I worked as a trader, I was often asked for financial advice. Unfortunately, the type of advice I could give my friends and relatives was of the non-specialist, common-sense sort that you see here every day at the Fool. This seemed to disappoint them; they were looking for a ‘hot stock’, or advice as to whether they should buy Euros for their holidays now or in six months time. Alas I couldn’t help them. Insider trading (even if I had known anything) was illegal, and the financial markets are full of Sabatier-sharp agents, who eradicate most anomalies faster than a pool of piranhas can consume someone from a Weight-Watchers starter class.
None of this is to say that forecasters and strategists are deliberately misleading or malevolent. However, even if some of them can transcend the ‘butterfly effect’, or can spot opportunities where the majority of traders cannot, how can you or I tell who they are? Looking at the track record can be misleading. The FTSE forecast I wrote above has a 50% chance of being right, even though it is complete nonsense. After three years of the same type of speculation I still have a one-in-eight chance of being 100% correct – and there are a lot more than eight market forecasters – and no-one expects you to be 100% right.
Forecasts, predictions, and strategies from the experts are NOT useless. You can learn much about the way markets and economies operate. However, you can only trust yourself if you make a prediction based on that information, and it’s better not to make a forecast at all; one made by a Nobel Prize winner is little better than one made by Mystic Meg.
Source: Yahoo Finance