I ran across one of Howard Marks’ earliest Memos from before his Oaktree days. The topic was the value of forecasts, which he thoroughly explains where the value lies.
Accurate forecasts aren’t enough. You have to be accurate and your forecast must translate into above average returns. You have to be better off than doing nothing.
Just being right is hard enough. You also have to predict how the market will react, you have to act on it and get the timing right, and the result of all that needs to be worth it.
That’s a lot to ask for when predicting the future. Here’s Marks:
The fact is, most forecasters predict a future quite like the recent past. One reason is that things generally continue as they have been; major changes don’t occur very often. Another is that most people don’t do “zero-based” forecasting, but start with the current observation or normal range and then add or subtract a bit as they think is appropriate. Lastly, real “sea changes” are extremely difficult to foretell.
That’s why some of the best-remembered forecasts are the ones that extrapolated current conditions or trends but were wrong. Business Week may never live down “The Death of Equities” and “The Death of Bonds.” At the mid-1990 lows, the press suggested that no one would ever buy a high yield bond again. In 1989, nobody thought the Cowboys would ever win without Tom Landry, or that the Lakers or 49ers would ever lose. Six years ago, the growth of both coasts’ economies was considered assured, and the Rustbelt’s suffering was expected to continue forever. Only two years ago, George Bush was a shoe-in.
Take high yield bonds, for instance. In 1989 and 1990 they absorbed a continual beating as a series of negative developments came together. There was the recession, the failure of a number of the leveraged buyouts of the 1980s, enactment of excessively stringent regulation and the collapse of Drexel Burnham, Columbia Savings and Executive Life. All of this was tied together — and accentuated — by lots of overly negative publicity.
Each development was another drip of “Chinese water torture.” Each one put an end to some investor’s ability to remain optimistic. And so each one eliminated a potential buyer, created a seller and moved prices lower.
And after all, what is a market bottom? It’s that moment when the last holder who will become a seller actually does so — and thus the moment when prices hit levels that will prove to have been the lows. From that point on, with no one left to turn negative, a few pieces of good news or the arrival of a few buyers with belief in values are enough to turn a market.
So you can see that the crescendo of negativism, the lowest prices and the greatest difficulty in predicting a rise all occur simultaneously. No wonder it’s hard to profit from forecasting.
Let’s say the average investor was approached in October 1990 by someone who had enough imagination and courage (because that’s what was needed) to make a positive case for high yield bonds. Would the investor have believed and bought? Probably not.
Potentially-profitable non-consensus forecasts are very hard to believe and act on for the simple reason that they are so far from conventional wisdom. If a forecast was totally logical and easily accepted, then it would be the consensus forecast (and its profit potential would be much less).
So if someone told you the U.S. auto makers’ share of domestic market was going back to 100% in five years, that would be a forecast with enormous implications for profit. But could you possibly believe it? Could you act on it?
The more a prediction of the future differs from the present, (1) the more likely it is to diverge from the consensus forecast, (2) the greater the profit would be if it’s right, and (3) the harder it will be to believe and act on it.
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- Why Didn’t Electricity Immediately Change Manufacturing? – T. Harford