Off with their talking heads
One of the few growth industries in these hard times is the investment punditry business, which seems to be expanding endlessly. Not a day passes without some fuss being made over an investment guru pontificating on where the markets are heading.
The most remarkable aspect of this is the deference with which their predictions are treated, although it has been systematically shown that - at best - most forecasters manage to get things right no more than 50 per cent of the time, while many of them get it spectacularly wrong. Yet no one seems to notice.
In one of his more acerbic remarks, economist John Kenneth Galbraith said: 'The only function of economic forecasting is to make astrology look respectable.' Yet the investing public clearly yearns for both economic and market forecasts, believing that if wise men and women can predict the future, this knowledge can be used to make small fortunes. The truth is that in investment, as in practically everything else in life, outcomes are hard to predict.
Just how hard is reflected in a study conducted by economist Tim Harford, who looked at forecasts for Britain, the United States and the euro zone from 2002 to 2008. He concluded that not only did forecasters have a tendency of clustering around similar predictions (a finding echoed in many other studies), but that in this period they were also more wrong than right.
In a 1998 book by William Sherden called The Fortune Sellers, 48 turning points in the US economy were examined. Sherden found that in all but two cases most forecasters had failed to predict these events. His general conclusion was that economic forecasting was no better than guessing and that when it came to official bodies such as the Federal Reserve, the Council of Economic Advisers and the Congressional Budget Office, their forecasts were worse than chance.
So, if it's hard to get the macroeconomic picture right, what happens when it comes to market forecasts? Unsurprisingly, the record is no better. A study published by the US-based CXO Advisory Group this year looked at the record of stock market forecasters over a two-year period. The survey embraced 5,700 measurements and more than 60 so-called gurus. It showed that they achieved an average 47 per cent overall accuracy record.
Why is the record so dismal? Aside from the obvious problem that forecasting is so damn difficult, what academic research shows is that not only do forecasters tend to cluster, but they also tend to pay undue attention to the immediate past when predicting the future.
An additional problem is that too many of the high-profile gurus are on the sell side of the equation. They have funds and stocks to sell and are therefore disinclined to be gloomy about market prospects. Were it otherwise, they would run the risk of turning away business. Even in bull markets, these same sell-side guys are given to flights of excessive optimism combined, paradoxically, with bouts of excessive caution because they find it hard to believe just how good things are.
Then there are the gurus who have made a name for themselves as a result of particularly good market calls and who are expected to be able to repeat this performance time and time again.
Christina Fang, an associate professor at New York University's Stern Business School, tracked The Wall Street Journal's survey of economic forecasts to see how gurus who made good calls on big events performed overall. In a radio interview, she said: 'If you look at the extreme outcomes ... people who correctly predicted either extremely good or extremely bad outcomes, they're likely to have an overall lower level of accuracy. In other words, they're doing poorer in general. Our research suggests that for someone who has successfully predicted those events ... they are not likely to repeat their success very often.'
Fund manager John Paulson is among those famous for a good call with his massive bet against the US subprime mortgage industry in 2008. No one says this wasn't a brilliant call, but his predicting abilities must be dwindling. Anyone investing in his Paulson Recovery Fund last year would have cause to question his prescience, as its price shrank by 31 per cent; his Advantage Fund performed even worse.
Anthony Bolton, the star fund manager at Fidelity, is another regular on the punditry circuit, and for good reason. He had an enviable track record with his Fidelity Special Situations Fund. But last year he decided to move to Hong Kong and launch the Fidelity China Special Situations investment trust. Asia, he declared, was where the real action was to be found. It was an attractive message, and there was a barrage of publicity surrounding the fund's launch. But by the end of the year, the fund's share price had slumped by almost 40 per cent, worse even than the dismal overall performance of the mainland stock market.
Jim Rogers, another investment guru, also uprooted his family to live in Asia, much on the same grounds as Bolton, although he opted for the delights of Singapore. At last year's Reuters Investment Outlook Summit (note the grandiose titles given to these punditry events), Rogers made a number of predictions. Among them was the idea of betting against treasuries. But treasuries turned out to be one of the best financial investments of the year. Attached to this prediction was a confident forecast that interest rates would go 'much, much higher' in the next few years. This may still happen. But meantime, rates have remained stubbornly low. He also predicted that the US was poised for a lost decade, yet the American economy has returned to a respectable growth trajectory.
Rogers was right in warning of a bubble in urban Chinese coastal region real estate prices, although the bubble was already deflating when he made the prediction. He was also more or less right about a rise in commodity prices up to April. But from there on, commodity prices overall steadily declined, reaching the year end with an anaemic rise of just below 6 per cent. Rogers said in December 2010 that he was holding euros, although he thought the currency was looking doomed in the longer term. That call is looking better these days.
It may be argued that taking a one-year view of investment predictions is somehow unfair. But for specific investment advice to have any meaning, a one-year time span seems reasonable for judging performance, not least because the pundits themselves favour it.
Let's turn to another Asia-based guru, Marc Faber, who made his name by correctly calling the 1987 crash and has relished the title of 'Dr Doom' ever since - even when markets boomed he remained deeply sceptical. Nowadays he is far more circumspect in making market calls. But at the beginning of last year, he made a number of predictions. Among them was the observation that natural gas prices were relatively low and would rise in the next few years. By December 31, the price of natural gas had fallen 25 per cent.
He was also bullish on precious metals. As the gold price soared to US$1,900 per ounce in September from around US$1,400 at the beginning of the year, this looked like a good call even though the price slumped back again to about US$1,600 at the end of the year.
But Faber postulated that, in a bull market, silver could outperform gold. In fact, silver ended the year flat, despite an impressive price spurt in April. Unlike Rogers, Faber correctly predicted a low-interest rate regime and was right about rising oil prices. He also made a good call on the strength of the US dollar, unlike fellow pundits, who were busy talking it down. Yet he said: 'My preferred currency remains gold and silver.' In addition, Faber liked the look of high-yield equities, an investment theme that has since become more popular.
Faber, therefore, had a relatively good year for punditry last year, while Rogers' record was far less impressive. This almost perfectly matches the overall 50-50 record for pundits. It reinforces the iron rule that even the best are not good all the time.
Where does this leave the average investor looking for guidance? Unfortunately, the answer is there is no magic crystal ball. Everyone just needs to accept that in investment, uncertainty rules.