Should You Rely On Predictions To Choose Investments?

There was a fantastic quote by a guy called Thomas Carlyle who described economics as a dismal science and the reason he did that was in reference to a prediction made by an economist named Thomas Malthus, who forecasted that the rate of growth of food supply in the world, compared with the rate of population growth, just wasn’t going to keep pace and the result was going to be mass starvation.

Obviously, that prediction was probably made over 150 years ago, but you can start to see that over history, time and time again, there are very prominent people who use things like economics to predict what will happen and find that they get it wrong.

How Economics was Taught

If I were to step back a little bit when I went to university and studied economics, there was a lot of math, graphs, and formulas trying to describe what happens to the economy when different economic levers and pressures are applied and then how people would react. 

Based on my memory, economics was taught as a mathematical exact science. Since then, I’ve tuned into a lot of very intelligent people making proclamations about the future as if it were a simple math equation.

I’ve been fascinated as I’ve observed over the last 15 or so plus years that there are people making forecasts over and over again and using those forecasts to influence investors.

But then we discover that those forecasts were wrong or at best lucky.

I think economics is now generally talked about as a social science because a lot of critics will say that economics falls short of the definition of science because there’s a lack of testable hypothesis, a lack of consensus, and political changes and policies can have a massive impact on how different levers are pulled and then impact our economy.

All those things combined make me agree with the idea that economics is actually less of a science and more of a study of human behaviour.

Who is Robert Shiller?

One of the people who I’ve read about in reference to this is a guy named Robert Shiller, who’s a Nobel Prize-winning economist, and the reason that he won the prize is that he’s had a really fantastic ability to predict bubbles, and I’ve heard him even described as the godfather of bubbles.

 But one of the things that I’ve seen in interviews is that he has quite a lot of humility when he’s asked to predict the future.

 He is highly sceptical of his own ability and actually says, “I’m not able to accurately predict the ups and downs of the market.”

 When he’s asked to predict what will come next, what I love is that he focuses more on the “maybe” or “I don’t know” and he’s very soft in his belief and in his own ability to predict what is going to happen in the future.

 My sense is, if someone who is a Nobel Prize-winning economist feels that there’s doubt about his own abilities, then why are there so many wealth experts, property experts, and share experts out there screaming to the hilltops that they know exactly what is going to happen in the future.

 There’s a fantastic quote by Morgan Housel, who interviewed Robert Shiller, and he said that predictions by those with poor track records are given out like candy.

 I think that’s slightly humorous, but it’s also a true reflection of what we experience as investors in our everyday world.

“Predictions are the Equivalent of Random Guesses”

There are so many people out there who are claiming that their analysis of the market is a surefire interpretation and that their prediction is correct.

There are so many studies over time and there are experts out there from a scientific perspective who look at these predictions with a great degree of certainty that predictions are the equivalent of random guesses.

The problem for new investors, or any investors, is that you might put yourself in a situation where the loudest voices, the voices that manage to make it onto the media and new channels that you perceive as credible, are the ones that will have the most influence.

There’s definitely an element of something to some degree becoming a self-fulfilling prophecy. 

But I think the big takeaway that I want investors to have is that it’s really difficult to predict with any accuracy what the future holds. 

There’s another quote by Daniel Gardner who says that those who make predictions about the future are lying, even if by chance they’re later approved.

“The Great Depression: A Diary”

One of the things I mentioned at our mastermind a couple of weeks ago was that I talked about this fabulous book called The Great Depression: A Diary.

It was essentially a diary maintained by a lawyer during the Great Depression, and it’s a fascinating read. There are a lot of great takeaways that we talked about.

But essentially, millions and millions of people have spent time thinking about framing up, quantifying, and hypothesising the questions that he raises in that book as a lay person, and we haven’t even come up with any bulletproof answers or even a consensus around them.

So let’s go back to the idea of when people who’ve dedicated their entire lives to the study of economics and the psychological impacts that money and wealth have on behaviour can’t get it right, how does the layperson do it?

Four Questions from Benjamin Roth

He raised four questions in his diary that highlight the fact that no matter how prosperous the global economy has been for the past century, we still don’t have answers to some of the most basic questions that he obsessed about.

One of the questions he had was, “How much debt is too much debt?” Whether we are talking about a household, a company, or a government.

Then the second question he asked over and over was, “What is the most secure way to guarantee a return on investment without excessive exposure to risk, and what is excessive risk?” 

That question has been debated to the nth degree, and there’s still no consensus on the answer to that question. 

The third question that he raised, which I think is really crucial for anyone who’s trying to succeed as an investor, is, “Why can’t economies continue to expand at a steady, manageable pace?” Why does the economy continue to lapse into destructive boom and bust cycles? Like, why can’t it just be a steady growth? Why is it up and down? 

The fourth and final question is, “How much can governments intervene?” How much can governments prop up a private enterprise without creating a moral hazard that actually hinders the markets?
 

Three Kinds of Prediction  

The reason I’m bringing this up is that I’m continuing to hear from many investors who are relying on expert opinions put out there by people that don’t necessarily support the data. 

This leads to the key point that I want to make today, which is that there are three kinds of predictions. 

We want to be really mindful when we are looking at people’s predictions of the future and take this into consideration. 

The first kind of prediction is when people find data and then use that data to make predictions. This is seen as probably one of the more credible types of prediction because people like actuaries, mathematicians, and psychologists use data with some degree of training and authority to try to make a prediction. 

The second kind of prediction is where people have theories about what they think will happen and then they find the data to support those predictions. 

Then the third kind of prediction is where people just have a vested interest and they make up a prediction and then speak with authority. 

The problem is that when things are uncertain, as they are right now, we tend to look for strong voices. 

We tend to look for leadership to guide our behaviour and provide examples of what to follow.

Don’t Believe in Forecasts

The point I want to make is that everyone is a guru with the benefit of hindsight. 

Everyone can be a guru when things are rosy. I have seen a lot of literature over the last year or two of people congratulating themselves as experts because they happened to predict that, for example, property should have been purchased over the last two years. 

I get that it’s easy to look like a guru with the benefit of hindsight, but the point I want to make is that forecasts are really terrible things to hang your hat on when you are thinking about making investment decisions. 

The big takeaway is that there’s nothing wrong with listening to people’s opinions on what will happen in the future, but as long as you are cognisant of how those predictions have been made and use that information in the context of everything else going on in the world to make a decision that, on balance, makes sense to you rather than blindly following forecasts for what people say is going to happen in the future. 

The reality is that predictions are always going to be coloured by whatever data or opinions you have available to you at the time. 

I’m not saying that people who make predictions are bad people, but I would say to you that it’s really important to use data in combination with opinion, add a strong dose of scepticism, and layer all of your decisions with this idea of thinking in terms of probabilities.
 

Final Thoughts 

The reason that I wanted to record this podcast today is that the world is full of strong opinions right now.

I even read yesterday that someone who’s very prominent in the US press was encouraging investors to sell everything they have right now on Wall Street, on the stock market.

I look at that as one very strong, loud voice in a sea of other, potentially more rational voices.

But I would look to the people who have the results that you want and ask them, what they are thinking and feeling and what they are observing rather than making rash decisions based on what could be a fairly superficial analysis. 

The other thing that I would say to you is that there’s a huge lag between the timing of data being published and its impact on the economy actually being felt. 

We’re certainly seeing that in the market right now, as we see some seriously heavy discounting going on in the real estate market, where people are so desperate to sell out of their properties that they’re accepting, in some cases, 20% lower than the asking price, just to get the liquidation or the liquidity event happening.

So tread carefully, don’t panic, and really ask yourself what makes sense before you make wild decisions. I think that’s really the summary of today’s session.

But anyway, I certainly am open to disagreements with my perspective. I’m certainly not saying that my voice is the only voice out there. 

I’m really open to people reaching out and sharing ideas that they want to talk about.

So till next time, guys. Take care and stay safe.

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