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Forecasting—More Art or Science?

Many people from all walks of life seem to enjoy reading articles or listening to shows where “experts” forecast the future. Predicting what will happen in the future is one of those basic human behaviors that seem so appealing. Who wouldn’t want to invest 10 minutes of their time to listen to an expert who, in that small timeframe, will provide the audience with some ingenious piece of information that will allow them to get rich quick?

Unfortunately, just because someone has excellent knowledge about a subject matter does not necessarily mean this individual will be able to predict the future accurately. As psychologist Philip Tetlock points out, “specialist knowledge does not enhance forecasting ability to any degree, and in fact, the specialists with the biggest reputations to defend and maintain often make the worst forecasts.” Here are some well-known forecasts gone wrong:

  • "The Americans have need of the telephone, but we do not. We have plenty of messenger boys." –Sir William Preece, Chief Engineer, British Post Office, 1878.
  • "The cinema is little more than a fad. It's canned drama. What audiences really want to see is flesh and blood on the stage." –Charlie Chaplin, actor, producer, director, and studio founder, 1916.
  • "There is not the slightest indication that nuclear energy will ever be obtainable. It would mean that the atom would have to be shattered at will." –Albert Einstein, 1932.
  • “The truth is no online database will replace your daily newspaper.” –Clifford Stroll, Newsweek article, 1995.

Forecasting is an inexact science. However, some traits can improve one’s ability to project the future with accuracy (to an extent). In Superforecasting, Philip Tetlock and Dan Gardner discuss some important qualities of superforecasters, including:

  • Employing a philosophical outlook that is cautious, humble, non-deterministic
  • Having a thinking style that is open-minded, curious, reflective and numerate
  • Utilizing a forecasting style that is pragmatic, probabilistic, analytical and can be thoughtfully updated when necessary
  • Having a work ethic full of grit and a mindset oriented toward growth

While it is possible to become a superforecaster, it is rare to find a single person possessing all the above characteristics and even more uncommon to find someone who can consistently use the above approach in a non-biased, clear-headed manner.

In reading Lazard Asset Management’s June 2019 Insights article entitled The Art and Science of Forecasting, the author points out that in study after study, researchers have discovered that forecasts are primarily inaccurate largely due to the existence of well-known biases. Other techniques may be used to combat the biases and improve forecasting accuracy:

  • Remembering that “the future is a horizon, not a point.” Providing a range of outcomes is preferable to providing a single point. To predict that the S&P 500 is going to end the year at exactly 3,074 seems both ridiculous and unhelpful, as opposed to providing a range, let’s say somewhere between a level of 2,925 and 3,225, which seems more credible and likely.
  • The evidence also suggests that forecasts made in isolation are not as accurate as those undertaken using a team approach. There appears to be a “wisdom in teams” effect that shows up across the studies. Teams do well as do averages of individual forecasts.
  • Assigning confidence ratings to one’s predictions assists in increasing accuracy. Too often, we take a black and white approach, when, in reality, there are shades of gray in between.

As Annie Duke says in her national bestseller, Thinking in Bets, “when we express our beliefs, they don’t generally come with qualifications. What if, in addition to expressing what we believe, we also rated our level of confidence about the accuracy of our belief on a scale of zero to ten? Forcing ourselves to express how sure we are of our beliefs brings to plain sight the probabilistic nature of those beliefs, that what we believe is seldom 100% or 0% accurate but, rather, somewhere in between.” Duke astutely goes on to say, “incorporating uncertainty into the way we think about our beliefs comes with many benefits. Acknowledging uncertainty is the first step in measuring and narrowing it.”

While forecasting is fraught with peril, some steps can be taken that help to alleviate the possibility of a missed forecast. At Wolf Group Capital Advisors, while we strive to be superforecasters, we are humbled to know that we cannot predict the future. Therefore, when building client portfolios, we always assess and monitor the prevailing risks in the economic and financial environment, giving us the ability to construct durable portfolios for the long-term and to optimize the risk to return trade-off. Our vigilant yet non-deterministic approach allows each investor to be comfortable holding their diversified portfolio regardless of the current market environment, with a consistent reminder that the future horizon is long-term.