The Fallacy of Forecasting Markets or the NCAA Tournament
Do you follow the NCAA Basketball Tournament? Even if you don’t, it impacts you.
An oft-cited report once indicated that the opening week of March Madness (the NCAA Basketball Tournament) cost employers nearly $4 billion in revenue due to lost productivity.
Besides sports bars and chicken wing suppliers, most companies will not benefit from the March Madness season. And only a relative few people will be lucky enough to win an office pool.
But why is so much time and money spent trying to predict the outcome of not just one or two, but 67 games?
- There are loyalties and biases toward alma maters, conferences or regions.
- There’s the adrenaline rush of correctly predicting the outcome of games.
- And, hopefully, there’s still the joy of seeing your favorite team win.
Of course, the tie-in is that this annual exercise of predicting the Tournament is not that different from market and economic forecasting.
That is, it’s difficult to consistently do it well.
You could give 100 economists the same exact information and you’d probably get 100 different opinions about where the economy is headed.
But let’s just assume that you had a special gift and you could identify the five economists who would be the most accurate. Would that change how your portfolio is invested? Perhaps. But maybe it wouldn’t make much of a difference, at all.
Suppose that you could predict with perfect accuracy the direction of the economy and the stock market over the next year? Let’s say:
- You know the economy is going to grow exactly 2.3% in the next year.
- You know that the stock market will gain 4.5%.
- You know that the bond market will give you a 2.6% return.
Yet, if you’re investing for your retirement (or you’re already retired), would one-year’s-worth of information help you with your portfolio for the next 10-20 years?
If you’re roughly 50% invested in diversified fixed income, and 50% invested in diversified global equities, having access to a single year’s worth of information probably wouldn’t necessitate a change in your portfolio.
And if you’re correct on your predictions 51% of the time, will this dramatically impact your portfolio?
Maybe, but what if you are wrong when it mattered most or right when it mattered least? What if you were taking out distributions and the market crashed and later rebounded to your forecasted level? There are just too many unknowns.
Does that mean that all forecasts are worthless?
No. It means that what matters most is your individual situation. Just some of the variables that should impact decision making include questions such as, what are your:
- Long and short-term objectives?
- Liquidity requirements?
- Risk tolerances?
- What does your cash flow look like?
- How much debt do you have?
- Where do you plan on moving if you are downsizing?
- How much money will you spend once you retire?
- Do you anticipate any increased spending due to health concerns? (hint: Yes!)
- How much money would you like to leave for your family or to charity?
There are so many factors and variables that are unique to you.
Here’s a warning.
If you come across an advisor who puts 90% of all their clients in the same strategy or product, beware!
Those clients have varying needs and levels of willingness to take risk. Some may need more income while some may need more growth. Even if we could tell you with perfect foresight exactly what the market will do, and when, on average, no two clients would likely have the exact same portfolio because they most likely have different objectives, comfort levels of risk, and funding needs.
Forecasting accurately and consistently is extremely difficult.
We look at many different variables, so we never place all the weight on one variable or one forecast. The differences can be instructive in terms of how much consensus there is for prices to move higher or lower and how wide is the margin of error.
When using weightings or probabilities, we can estimate a range of likely outcomes of many forecasted variables. We can even come up with best case and worst-case types of scenarios. (These can be helpful when trying to figure out how much of a cushion you need or if you have enough money to take less risk.)
If you only need 5% per year in retirement, it doesn’t make sense to build a portfolio that is targeting 10% per year. Remember, with a higher return target there is probably more risk. Conversely, if you don’t need a lot of insurance, you shouldn’t be overly insured.
Given the wide variety of data that is out there, it’s difficult to say the market will go higher or the market will go lower. That’s because:
- Fundamentals look good, but not great.
- Earnings are slowing.
- Valuations look okay, but certainly not great.
- The economy is strong but may be slowing down.
- “Technicals” look like we could go sideways for some time.
- In the very short term, prices may move higher.
- In the intermediate term, prices may move lower.
- Over the very long term, prices will likely move higher.
Make no mistake, we will eventually have a bear market, but no one knows:
- When it will start.
- How deep it will be.
- When or how it will end.
It’s impossible to say with certainty where we will be in one month, let alone a year.
As with college basketball, it is one thing to say that Duke or North Carolina or Tennessee have a decent probability of making it to the Final Four.
It’s entirely different to say with any confidence, no matter how many experts you listen to, that all 67 games will happen exactly as predicted.
Coming up short is the madness factor. Don’t let the pursuit of short-term forecasts ruin the bracket that is your portfolio.
If you have questions about investing, retirement, or tax planning, contact us today.