If you follow the financial media regularly, you will find daily predictions about the direction of the markets. Breakout, a daily blog on Yahoo Finance’s website, is typical of what passes for financial information. On September 6, Breakout’s Jeff Macke featured Mike Jackson, the CEO of AutoNation, as his guest. Jackson opined that the economy “has moved into a self-sustaining recovery.” He may or may not be correct in that assessment, but relying on his views or the views of others claiming predictive powers is more akin to gambling than investing.
Macke’s program is no worse than what is dispensed by many of his colleagues in the media. The format is familiar to all of us: Intelligent people in positions of power and influence make rational-sounding statements about the economy, the direction of the market or the merit of a particular stock or fund. What’s missing is any data indicating that their views are worthy of consideration, based on a history of accurate past predictions or demonstration of predictive skill (as contrasted with luck).
There is ample evidence to the contrary. In a paper published in July 2010, three finance professors from Duke University and Ohio State University published the results of an extensive survey they performed. Each quarter from March 2001 to February 2010, they surveyed “top U.S. financial executives.” They asked them to predict one- and 10-year stock market returns and also for their predictions of best- and worst-case outcomes. The data they gathered aggregated 11,600 S&P 500 forecasts.
You would think the accumulated expertise of these executives would permit them to make fairly accurate predictions about a commonly used index such as the S&P 500. The opposite was true. The authors of the study found no correlation between the estimates of these top financial executives and the actual value of the index. In fact, the correlation was negative. When they predicted the index would decline, it was modestly more likely it would go up.
Nobel Laureate Daniel Kahneman commented on this study in his book, "Thinking, Fast and Slow", noting, “These findings are not surprising. The truly bad news is that the CFOs did not appear to know that their forecasts were worthless.”
Since the data is overwhelming that predictions are basically “worthless,” why do investors continue to pay attention to them, often to their financial detriment? Kahneman provides this answer: "Facts that challenge such basic assumptions – and thereby threaten people’s livelihood and self-esteem – are simply not absorbed. The mind does not digest them."
If investors accepted the fact that the predictive views of financial “experts” were “worthless,” the ramifications would be profound. Much of the financial media would cease to exist. Brokers would go out of business because clients would view their advice through the prism provided by sound academic studies and the views of scholars such as Kahneman. This result – threatening the livelihood and self-esteem of powerful segments of our society – is simply not going to happen.
While much of the financial media and many brokers are driven by this secret agenda to maintain their livelihoods, you should ignore their musings and base your investing decisions on reliable, peer-reviewed data.
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth advisor with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You’ll Ever Read, will be published March 3, 2014.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.