Forecasting the financial impact of political events, especially elections, is a popular activity among investors, analysts, and those "talking heads" that seem to be everywhere during election season. There's just one problem: no one is very good at it. As "The Black Swan" author Nassim Taleb aptly points out, “Our track record in figuring out significant rare events in politics and economics is not close to zero; it is zero” (Antifragile, pg. 150). This statement underscores a crucial point: our collective ability to predict significant political and economic events is abysmal.
And it's not just armchair politicos and wannabe day traders that stink at forecasting the future. As contrarian investor David Dreman's research shows that most Wall Street consensus forecasts miss their targets by significant margins, often by more than 15% (Contrarian Investment Strategies, pg. 374). From 1973 to 1993, out of nearly 80,000 estimates, only 1 in 170 were within 5% of the actual number. Montier adds that in 2000, the average target price was 37% above market price, but the market ended up only 16%. In 2008, the forecast was a 28% increase, yet the market fell by 40%. Analysts failed to predict the correct market direction in four out of nine years between 2000 and 2008. (All stats from "The Little Book of Value Investing" by Browne).
The situation gets worse when considering the experts we most often listen to. Philip Tetlock's exhaustive study of 82,000 predictions over 25 years by 300 experts concluded that expert forecasts are barely better than random guesses. Tetlock also found that the more confident and famous the expert, the worse their predictions tended to be. In other words, those who are most confident in their forecasts are often the least accurate.
The reasons for these poor outcomes are multifaceted. Financial experts, often highly educated and successful, tend to exhibit boldness and confidence in their predictions, which can lead to hubris. As Dr. Brian Portnoy explains, experts become comfortable making bold predictions due to their extensive knowledge (https://www.amazon.com pg. 36). However, this confidence often results in poor forecasting outcomes. Tetlock found that experts with over 80% confidence in their predictions were correct less than half the time. (https://www.thriftbooks.com)
Additionally, the most famous forecasters often make bold predictions to maintain their public profile. These predictions, usually based on dramatic events like market crashes or booms, are rarely accurate in less dramatic times. Consequently, these experts underperform compared to their less prominent colleagues.
In light of this evidence, it is crucial for investors to remain calm and focus on what they can control rather than trying to predict the political future and its impact on the markets. This is a time for working with your advisor and sticking with your plan and your personal benchmark, not consulting a necessarily murky political crystal ball. By acknowledging the limitations of forecasts and the fallibility of even the most confident and famous experts, investors can avoid the pitfalls of prediction and instead adopt a more stable and controllable approach to their financial decisions.