Overview
Many people enjoy making predictions about the future, whether it’s for fun or for serious thought. I occasionally find myself making predictions for the sake of entertainment.
While making predictions is a very natural thing to do, problems arise when we start to place too much faith in what to expect in the future. So many people predict certain events will transpire in the future, only for those events to never materialize at all.
One of the defining features of investing & finance is the unhealthy obsession of making predictions.
There is no shortage of forecasts, conjectures, and hopes in the fields of investing and finance. Whether it’s a quarterly report, an annual report, a high-profile securities analyst, high-profile political figures, or prominent CEOs, an abundance of predictions are made daily and can be found everywhere.
With so many guesses being made, it is very easy for an investor to get caught up in overly optimistic, or pessimistic, views of the future while forgetting that no one can truly predict what’s to come.
Argumentum Ad Verecundiam
When debating with someone, a commonly used technique to lend credence to an argument is to cite a prominent figure, otherwise known as an “authority”, and to make the connection that “because this authority said this, my argument is valid.”
In philosophy, this practice of attempting to prove a point because a prominent person or figure made the same point is called the argument from authority, or the appeal to authority fallacy.
While appealing to authority can sometimes make an argument stronger, relying too heavily on it can lead to some issues, especially if the authority is attempting to validate something outside of their expertise.
One of the most prestigious titles in the financial (and political) world is the Chair of the Federal Reserve (commonly referred to as the “Fed Chair”). This individual is the head of the Federal Reserve, which is the central bank of the United States.
Because this position commands so much power and influence, it is not uncommon for the Chair to comment or make predictions about the current or future state of the U.S. and global economy.
It is very easy for investors to heed the words of the Fed Chair as near-irrefutable, simply because of the authority they possess. Not to mention that the Fed Chair is usually a high-profile economist in their own right.
However, justifying investment decisions based on what the Fed Chair said is a classic example of the appeal to authority fallacy.
Ben Bernanke, the Fed Chair from 2006 to 2014, previously said that in light of mortgage defaults from subprime mortgages, they did not present a risk to the economy. Clearly, he was off the mark with this statement when subprime mortgages were the primary catalysts behind the Global Financial Crisis. Investors who ignored the reality that subprime mortgages were becoming an increasingly bigger problem would be in for a very big surprise.
Janet Yellen, the Fed Chair from 2014 to 2018, previously said that she does not believe another financial crisis will happen in our lifetimes, citing improved banking regulations in the aftermath of the Global Financial Crisis. She probably would never have imagined that a global pandemic a few years later would rock the global economy and financial system. Just because the Fed Chair believes that a major financial event won’t happen during our lifetimes is not an excuse to be overly bullish.
The Fed Chair is not the only authority investors cite to prove a point. As I mentioned previously, prominent CEOs & other high-profile executives, heads of state & high-profile political figures, and even writers from prestigious financial news outlets such as The Wall Street Journal are known to give their fair share of predictions for what is to come.
Time and time again investors repeatedly base their decisions based on these predictions, simply because the prediction came from someone or something with authority.
Investors, especially young investors, need to remember that predictions are, at best, slightly educated guesses, and at worst ways to spread fear and misinformation. It doesn’t matter who or what made a prediction, they should always be taken with a grain of salt and should never dictate your investment decisions.
Riding the Wave of Optimism (or Pessimism)
I’ve repeatedly come across countless investment “pundits” who claim to know when the next boom or bust will start or finish.
These sorts of predictions were widespread earlier this year, right after COVID-19 lockdowns were declared worldwide and markets around the world were upended.
Naturally, this started the discussion of “when will markets return to normal, pre-COVID activity?”
What followed was a flurry of speculations about what sort of recovery we would experience. Financial outlets tried to explain the different types of recovery. The Bank of Canada made the case for a V-shaped recovery. Even CEOs started to play the guessing game of how the global economy will recover.
With so many predictions being thrown around about when markets will start to resemble pre-COVID activity, new investors and speculators alike started to “buy the dip”, trying to load up on as many securities as they could before markets rebounded.
So many people got caught up in the whole “what shape will the recovery take?” frenzy, making wild predictions as to when certain market milestones will occur, and to plan appropriately for these supposedly impending events.
Any sensible investor understands that making decisions based on wild conjectures of when the economy will start to recover or begin to contract is a fool’s gambit.
No one knows for certain what a future economic recovery after COVID-19, or after any major financial upheaval, will look like. Attempting to buy or sell based on unjustified predictions never ends well.
Keep Expectations at Bay
Before companies release their quarterly or annual financial results, news outlets usually report expected financial results; earnings per share and revenue are two commonly predicted values.
When companies exceed these predictions, investors, analysts, and the markets rejoice, and the stock price usually goes up. But when financial results fall short of predictions, the stock price is quick in its decline, and panicked investors are even quicker in selling their holdings, all because expectations were not met.
I find this whole notion of people buying or selling investments, particularly stocks, just because they exceed or fall short of expectations to be very ridiculous. Making decisions because of expectations is a textbook example of being an emotional investor.
Personally, I don’t care if one of my companies meets, exceeds, or falls short of predicted earnings. Nor will I proceed to panic buy or panic sell just because reported earnings do not match predicted earnings.
If all it takes for you to lose faith in one of your companies is for them to fall short of predicted quarterly or annual earnings, you’re better off not being an investor at all.
When one of my companies is about to release their quarterly or annual financial results, I have zero expectations, and I absolutely do not care about what the predicted results are.
The only numbers that matter are the ones that are reported. Most predicted values are completely meaningless to investors – all they do is exacerbate unnecessary angst.
Regardless of what is reported, I do not make investment decisions by focusing on one quarter or one year’s worth of financial results. My decisions are based on several years, and sometimes decades, worth of financial data. One quarter or year is inconsequential compared to the time frame I normally work with.
The next time you find yourself obsessing over predicted results, know that just because earnings fall short of expectations, the enterprise does not immediately lose all its investment merit.
Not only that, but an investor should never base their investment decisions on only one quarter or one year’s worth of data, so even if a company falls short of expectations there should be no reason to panic. Stressing over one data point will do you no good.
The Past Does Not Perfectly Predict the Future
Lots of people, including investors, erroneously believe that the past can accurately predict the future. This false notion is exacerbated by the belief that the deeper the past, the better the prediction.
It’s true that investing is essentially the act of looking at the past in anticipation of what may reasonably be expected in the future. Investors lay down money today in the hopes of receiving more later.
An intelligent investor understands that there are no guarantees when it comes to investing. An investor seeks to make money with the hope that a strong enterprise today remains a strong enterprise tomorrow, based on what they’ve previously achieved and what they plan to achieve in the future.
No investor makes an investment decision based on perfect analysis with complete information. There is always an element of risk, no matter how small.
Yet so many investors spend so much time and effort attempting to predict what the market will do next, based on what it has done in the past. There exists an abundance of complex mathematical models, all of which attempt to make predictions about lots of different variables – securities prices, beta, future return, and countless more.
In science and engineering, it is commonly understood that data should never be extrapolated, even if there appears to be some sort of pattern. There is no guarantee that a previously observed pattern will repeat. There are instances where extrapolations must be made, but they are usually done over a very short range, with multiple assumptions about the extrapolated data.
Investors work with historical data all the time, so naturally, the thought of extrapolating data to make some predictions will occasionally cross their minds.
An investor should always remember that the past can never perfectly predict what will happen in the future. At best, the past can help make some inferences of what can reasonably be expected in the future, but a perfectly accurate prediction can never be made.
Humans naturally recognize patterns. It’s in our DNA to detect patterns and to convince ourselves the same pattern can be observed in the future.
Being a successful investor usually means frequently going against our psychological tendencies, which includes our knack for assuming patterns will repeat.
Just because a pattern is observed in the past, it does not mean the same pattern will be observed in the future. Successful investors know this, so any sort of guesses about the future should never be considered flawless.
Wrapping Up
The world of investing & finance is notorious for its propensity to make predictions, no matter how outlandish they may seem.
Investors must remember that predictions should never be taken as irrefutable and they should never allow predictions to dictate their decision-making.
It is no secret that investing is simply the act of making reasonable inferences about what to expect in the future, but an intelligent investor understands that there are no guarantees about what the future may or may not hold.
The past may provide some indication of what may occur down the road, but the past never has, and never will serve as a perfect predictor of what lies ahead. Always be wary of any sort of market predictions.
