“A spectacular zero” and advice from Janet Yellen
At the end of this post, I’ll explain the picture above and the advice Janet Yellen gave me. To start, though, most people know that I run an investment advisory firm and that, in the past, I held senior positions inside large Wall Street firms, giving advice to some of the firms’ largest private clients.
Because of this, I constantly get asked what I think is going to happen to the market going forward or for my picks of stocks or sectors that I think are going to perform the best.
I know that people like to hear a hot tip and, earlier in my career, when the firms I worked for were paying me to do this, I often tried to provide them.
Now, I’m older and don’t care as much about impressing people. In addition, in my professional life, I now get paid to shoot straight, tell people what I really think, and stay focused on the consistent findings of independent peer reviewed research versus selling proprietary forecast based trades and products.
What do I say now based on my experience and the evidence about what’s most likely to come to pass?
As Jason Zweig from the Wall Street Journal has suggested that more people in the investment business should, I say, “I don’t know.”
I’m sure a few people think that, when I do this, I’m taking the easy way out or being passive in my approach to investing. I understand why people might feel this way, especially when the word “passive” is used, which according to the dictionary means “inert” and has synonyms such as “acquiescent” and “compliant.”
Until very recently, and only due to more and more candid comments from people like Jack Bogle and Warren Buffett, the investment industry socialized both investors and industry professionals to believe that significant weight and value should be placed on estimates and actionable forecasts.
Because it sells.
Believe me when I say that the industry spends a lot of time and money training people about how to sell emotional presentations to different audiences. They know well that it’s much easier to acquiesce to the excitement of the presentation pitched by a haloed professional than to stay anchored on the evidence. Even though they know the probability of getting it correct is low, they also know they only need to be correct once to become famous and see large flows into their very profitable funds or products.
What does the evidence consistently show, however, about the accuracy of forecasts and analysts’ recommendations?
Like the old saying that is echoed frequently inside Wall Street, the presenters are never in doubt, but most often they are wrong.
I have written about this topic frequently, in publications such as the Street.com, WealthManagement.com, IRIS and on my firm’s website, in pieces like Talking Heads, where I shared over-cocktails quotes from what I called the Honest Global Chief Investment Officer.
I’m know I’m fighting a constant battle against the financial public relations machine, though, so below are a few more pieces of evidence supporting my contrary-to-the-herd point of view.
First, to independent research produced by Salil Mehta. Mehta and his fellow researchers have been collecting data on the accuracy of Wall Street forecasts for over 20 years. In one of his most detailed pieces, Desolated Admirers of Investment Strategists, he highlights compelling long-term data. It includes information that he’s sure Wall Street “emperors hope you forget.”
As he discusses, and as the industry knows well, most people won’t care much even when upside predictions are proven to be less accurate than a coin toss. If the market is up over 20%, as it was in 2017, people will tend to forgive conservative predictions that were commonly predicting single digit returns.
People focus more on pain avoidance, meaning that what investors really care about is downside protection – advice about when to sell before a bear market.
What does Mehta’s research show about how many times Wall Street consensus predicted a market drop?
“A spectacular zero.”
Unfortunately, this has been well known but generally ignored for quite some time.
As an example, CXO Advisory collected data from over 6,500 predictions made by 68 investment gurus covering the time period 1998 – 2012.
What did they find?
The accuracy of well-known investment strategy professionals, including industry luminaries Jeremy Grantham and Abby Joseph Cohen, was only 47%, or as Mehta found, also worse than a coin toss (see the following for the complete study – Guru Grades).
Finally, how about Federal Reserve leaders?
Take a look at the chart below. It is from a Wall Street Journal analysis of over 700 Fed policymaker predictions between 2009 and 2012. As you might expect, 1.00 is perfect, so it acts as a percentage accuracy score.
These data suggest that my picture mate, Yellen, is indeed impressive relative to her peers, but the last I checked, an accuracy rating of 52% is still about the same as a coin flip. And, before you think that I am being too hard on them, keep in mind that the Fed acknowledges in its own research that its forecasting leaves much to be desired.
As an example, the following is from a report published in February of 2015 by the Federal Reserve Bank of San Francisco based on a study of the Federal Reserve Open Market Committee’s Summary of Economic Projections (SEP):
“Over the past seven years, many growth forecasts, including the SEP’s…, have been too optimistic. In particular, the SEP forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently over-predicted the speed of the recovery that started in June 2009.”
That’s right, they completely missed the downturn and were overly optimistic about the recovery. Yellen reinforced this herself in a 2010 comment when she acknowledged that she “didn’t see any of that coming until it happened.”
The evidence suggests that market forecasts aren’t worth much, but this doesn’t mean you shouldn’t look at data. Data can absolutely help you develop a long-term plan you feel comfortable enough to stick with and not change based on short-term predictions. Like the enduring design approach of Steve Jobs, the best financial strategies evaluate all kinds of data then strip away everything that isn’t in simple service of the underlying goal.
It might sound overly simplistic or passive, but as I detailed last year in a piece for Trust & Estates magazine, How to Perform Better, keeping it simple has consistently outperformed even top university endowments.
So, what’s my advice?
The next time you hear an emotional investment prognostication, stay anchored on what Janet Yellen privately cautioned me with a smile, after she shared her market view.
“Just remember, my projections are based on estimates (yes, estimates based on estimates) and my assessments contain a considerable amount of uncertainty.”
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