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“The Folly of Prediction”

At times of market volatility when bad news is pervasive investors are often left wondering where to turn. Sometimes it can seem tempting to seek out commentators or other “gurus” with decided opinions and seemingly stellar credentials for having identified and called market crises in advance correctly in the past.

We at MASECO believe that making market predictions over the short term and trying to time financial markets is a futile exercise as it is all too often purely conjecture.  An example of this can be seen in the following recent Bloomberg story whereby Goldman Sachs abandoned five of their six  recommended top trades for 2016 –  just six weeks into the year. http://www.bloomberg.com/news/articles/2016-02-09/goldman-sachs-abandons-five-of-six-top-trade-calls-for-2016

Replacing a well thought out financial plan, underpinned by decades of empirical and academic evidence, with one “informed” by predictions can be a dangerous business. Why is it then that we can be drawn in by them when we feel vulnerable?

Professor Steven Levitt of Freakonomics fame offers the following explanation for why bad predictions abound:

So, most predictions we remember are ones which were fabulously, wildly unexpected and then came true. Now, the person who makes that prediction has a strong incentive to remind everyone that they made that crazy prediction which came true. If you look at all the people, the economists, who talked about the financial crisis ahead of time, those guys harp on it constantly. “I was right, I was right, I was right.” But if you’re wrong, there’s no person on the other side of the transaction who draws any real benefit from embarrassing you by bring up the bad prediction over and over. So there’s nobody who has a strong incentive, usually, to go back and say, Here’s the list of the 118 predictions that were false. … And without any sort of market mechanism or incentive for keeping the prediction makers honest, there’s lots of incentive to go out and to make these wild predictions.”

If you are interested in exploring this further the Freakonomics Radio podcast, “The Folly of Prediction”, can be accessed with the following link – http://freakonomics.com/podcast/new-freakonomics-radio-podcast-the-folly-of-prediction/

 

Cormac Naughten


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