Thursday, February 24, 2011

Predict with caution; heed with even more

One of the books I was assigned in my doctoral program is William H. Starbuck's The Production of Knowledge, which I thoroughly enjoyed and highly recommend. It can be viewed as a softer criticism of the idea of predicting the future than Nassim Taleb's The Black Swan. And while I also recommend Taleb's book, I would encourage you even more to read Starbuck's. I decided earlier this week that it is worthy of another read, and so I will shortly tackle it again.

Well, this is perhaps a rather long intro into an article that appeared in today's WSJ by James K. Glassman, perhaps best known for his fabulously popular, Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market, which I commented on earlier this month. As noted in that post, this book can be purchased today for a penny, though some probably would suggest that it's still overpriced.

Carlos Lozada in a March 8, 2009 interview in The Washington Post asked Glassman "[do you] feel the need to apologize to someone who read your book, went in and got creamed?," to which Glassman responded "Absolutely not." Although he doesn't apologize for his error, and perhaps shouldn't, he at least admits that he was wrong in today's article.

In the WSJ Glassman mentions "While history is usually the best guide to the future, it is far from perfect." I don't know what he bases this statement on, because I would argue that history isn't a very good guide in many respects. This is part of Starbuck's and Taleb's arguments against making any prediction. Glassman is correct that the idea of the United States having a black president at this point would probably have been considered a "pipe dream," or that the Saints would have won the Super Bowl, and on and on. But that didn't stop him from suggesting that the Dow would achieve such a lofty level in a rather short time.

But why did the WSJ, a paper that is highly selective in who they let write articles or position papers for, include this piece by Glassman? Yes, he has held (and still holds) some lofty positions, but his ability to predict or offer advice on investing is such that he's among the last who should be granted such privilege. Or am I mistaken? What do you think?

In spite of our poor job at predicting, people still want to hear what pundits have to say about the future. I see that Jim Rogers will speak at this year's CFA Institute annual conference. I have read a couple of Jim's books and find him to be highly intelligent and engaging. But I recall a prediction he made during Bill Clinton's first term in office when spoke at the NYSSA; he said that Clinton would be the last Democratic president. Well, that was a bold prediction and he, of course, was in error.

I recall that in the Old Testament the punishment for fortune tellers is death; and while I would never encourage such an extreme response, I do think that we should be careful what we believe when we hear pundits talk about the future, even when they're some of the brightest people around.


  1. Stephen Campisi, CFAFebruary 25, 2011 at 3:25 AM

    What's the difference between a prediction and a forecast? Why does anyone make recommendations and what is the basis for these recommendations? What do you expect people (readers, clients, etc.) to do with the information provided? And what are people expecting? Guarantees? Let's be clear - there are are only two kinds of "information" that investment practitioners provide: FACTS and OPINIONS. Facts are verifiable because they have already happened. Everything else is simply an opinion, regardless of what you call it. We cannot assign more value or predictability to an opinion simply because we call it a forecast, a recommendation and especially a "prediction." Those who listen and decide to act on the opinions of others (market forecasters, strategists, portfolio managers, analysts) have the responsibility of understanding the process used to develop the recommendation, assess its credibility and then decide whether or not to act on it, taking responsibility for their own decision to do so.

    We should also recognize that any and all ideas about the markets are generally based upon an analysis of historical data. Hopefully the data used is accurate and representative of the market's behavior over complete market cycles. But in the end, we are ALWAYS giving an OPINION about what is likely to happen next. And an opinion is only as good as the data it's based on, and the credibility of the analysis of that data. In the end, it's still an opinion and not a guarantee. So, to find that some investor is "shocked, shocked" that the opinion turned out to be wrong is an indication that a) the investor probably put too much money behind the recommendation and violated the first law of prudence and risk management, which is diversification and b) the investor trusted too much in the opinion of a single person, treating it as a guarantee rather than simply a recommendation and one person's opinion.

    Investors must realize that they themselves make their own decisions and bear the responsibility for their own actions. Equally important, they must understand the difference between investing and speculation. If they maintain a diversified portfolio, then they will not "lose their shirts" when a single recommendation turns out to be wrong. If they concentrate their investments in the hope of "making a killing on the market" then they deserve what they get for their own emotional and imprudent risk seeking behavior. It's that old saying "Bulls get rich, bears get risk, but pigs get slaughtered."

  2. Excellent response, Steve. It requires more reflection then perhaps I can give it right now. Of course investors make investments based on their expectations for the future. And, as you are no doubt aware, this is something even Taleb challenges completely. And you're right that there are no guarantees. If we're going to be "in this game," there has to be some degree of forecasting about the future.

    To some degree it gets back to how we couch these predictions. The Merrill qualification I provided in the past for their VaR is an example of such a qualification. But when someone writes a book touting the upcoming Dow at 36000, that seems like more than an opinion. Granted it was a way to make a lot of money.

    There are some individuals who make predictions with such forcefulness, with such confidence, that their listeners take it for granted that it's a fact, but you're right, it's only an opinion.

    I think my points are still valid, but you're right that we deal with forecasts all the time. It's up to the listener/reader to understand what they represent.

  3. Upon further reflection, I wish to add a few more remarks.

    Some pundits make their predictions with such bravado and confidence that they may utter the phrase, "you can take it to the bank!" I recall a sports show commentator discussing the post season baseball games, and didn't even bother to discuss the wild card matches, because it was a given who would win; well, he was wrong.

    To say "based on what I know, I expect ..." is quite different than "this WILL occur!" Jim Rogers' predictions about the future holders of the White House and I expect Glasman's of the Dow were probably along the lines of the latter.

  4. Stephen Campisi, CFAFebruary 26, 2011 at 10:45 AM


    You mention the "bravado and confidence" of the so-called pundits when they make predictions, and you also note that when these opinions are stated with such forcefulness that "listeners take it for granted that it's a fact." Herein lies the problem. The style, manner, glibness, confidence, hubris, audacity or WHATEVER the commentator brings is completely IRRELEVANT to this essential point: IT'S STILL JUST AN OPINION.

    One of the most important ethical guidelines that the CFA Institute has wisely noted in their Code of Ethics is the duty to "distinguish fact from opinion." Of course, in rendering an opinion one is responsible for doing the analysis using valid data, sound analysis based on accepted financial and economic theories and then rendering their independent judgment. The result of all this is still nothing more than an opinion. Hopefully, the analyst believes that their opinion is the most likely thing that will occur, and so they recommend that money be invested in line with their recommendation/opinion. But it is still an opinion.

    Investors cannot be swayed by the style of the person making investment recommendations. That's how charlatans ply their trade. "He seemed honest" is no substitute for exhaustive due diligence into the background of an advisor. "It seemed like a good idea" is no substitute for checking facts and analysis. If you don't understand it, you shouldn't invest in it. And to your point: "He seemed so sure about it. He rang a buzzer and waved his arms around a lot" is no reason to trust someone's recommendation.

    Seems I recall one such pundit banging a buzzer on his TV show exclaiming "Lehman's not going out of business. Don't be silly." Trust but verify.

  5. Steve, I agree with you. If I say that "given the information available to me, I believe XXX will happen," we have qualified our prognostication. However, if we simply say "this will happen" or "you can take it to the bank" then we've essentially implied a level of assurance to our prediction.

    A few years ago someone said something like "the world will end on May 5 at 9:00." This got a lot of attention because of the accuracy, both the date and time. Of course, I didn't know whether they meant AM or PM, or for that matter, what time zone. Oh, and you may have noticed, the world didn't end. Likewise, when I actually go to the trouble of writing a book with a title "Dow 36,000," we again have specificity, and this is enough to garner attention (which it did). The readers should, of course, take into consideration that this was the belief of two writers. And, the notion that the authors "owed" a reader who took their advice and acted on it "an apology" is probably asking a bit, but having never read the book I don't know how forceful they made their argument. Predictions won't go away; the key is to qualify them, as you suggest. And, for the listener/reader to recognize that these aren't stated as fact.


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