The season of forecasts is upon us, as experts share their opinions about what the new year will bring. I’ve seen a flood of predictions about how the economy and markets will fare in 2024 already. But it’s also time to consider how much weight we should put on these forecasts, and how investors can make informed decisions about their investments despite the inherent issues with forecasting.
Tis the season of predictions
Every December, the air crackles with anticipation – not just for the festive season, but for what the next year may bring. In financial markets this leads to the annual ritual of crystal ball gazing for the year ahead. Strategists, economists, and even your local barista offer pronouncements about the year to come, painting pictures of economic booms, tech revolutions, or, conversely, impending doom.
This month my inbox is full of predictions from well-meaning brokers. The predictions I’ve read so far include:
Economic growth in 2024 will undershoot forecasts
The great inflation surge will end
Interest rates will fall nearly everywhere
Elections (including in the US) will cause a lot of market volatility
A cyclical recovery will begin in China
But before you get swept away in the tide of opinions about what’s in store for next year, take a moment to consider that research shows experts are no more accurate than the layperson when it comes to forecasting.
Remember last year's chorus of economists predicting a near-certain recession due to central bank interest rate hikes? This time last year, 70% of economists expected a US recession, but this never materialised and the latest GDP data shows that US economic growth has actually accelerated in the US in recent quarters.
When Russia invaded Ukraine in February 2022, analysts predicted much higher oil prices should the war continue. Almost two years later, the war continues and Russia has significantly reduced its energy exports to Europe, but oil and gas prices are below pre-war levels by 20% and 44% respectively.
Having seen all of the 2024 predictions hitting my inbox, and reflecting on the misses from 2023, I decided to review the literature on how accurate the experts are, and why, like the rest of us, they often get it wrong.
The difficulties of forecasting
It turns out experts are no better at forecasting than an informed observer. This isn't because the experts aren’t smart – it can often be due to a combination of overconfidence, the inherent complexity of forecasting, and a desire from experts to stand out with bold, contrarian pronouncements.
A 2014 study investigated the accuracy of forecasting geopolitical events. Although experts displayed higher confidence in their predictions, their actual accuracy was no better than informed laypeople.
The experts often overestimated their ability to predict. This ‘overconfidence bias’ can arise due to their status as experts, given them the ‘illusion of control’ - where experts feel they have more control over their predictions than they actually do, and can lead to an inflated sense of accuracy. Experts were also found to suffer from confirmation bias, focusing on evidence that confirms their predictions and disregarding contradictory information. This can reinforce their confidence even when their forecasts are wrong. It was also found that experts can deliberately make bold predictions to stand out and gain attention, even if they lack strong evidence. This can lead to inaccurate forecasts in their pursuit of originality.
Perhaps as important as these biases, there is also simply limited ability to predict complex systems like economics and politics given they are influenced by numerous interconnected variables. Even the most sophisticated models struggle to capture these complexities, leading to inherent accuracy limitations.
A New Year resolution to make fewer predictions
So, what should we do in the face of this annual avalanche of predictions, and evidence that they aren’t very reliable? Perhaps this year, it's time to break the cycle and make a different kind of resolution: to stop making economic predictions and basing investment decisions on them. There are numerous reasons to adopt this approach and avoid making investment decisions based on short term predictions.
Firstly, the future is inherently unknowable and even the most sophisticated models can't account for unforeseen events, black swan moments, or the unpredictability of human behaviour.
Secondly, when we base our investing decisions on predictions, we become susceptible to fear and greed, buying high when things look rosy and selling low when panic sets in. This often leads to missed opportunities and suboptimal returns.
Finally, spending our time and energy trying to predict the future takes away from analysing the present, where we can make informed decisions based on fundamentals – what we know for sure, and what we can control.
If you can’t rely on predictions, what can you do?
Buy and hold: History shows that long-term investors who stay invested through market cycles tend to outperform those who try to time the market.
Focus on the fundamentals: Instead of chasing the latest fad or prediction, invest in companies with strong fundamentals, solid management, and clear competitive advantages.
Control your emotions: Don't let fear or greed dictate your investment decisions. Stick to your long-term plan and avoid impulsive actions based on market noise or other people’s predictions.
It might be tempting to think we can outsmart the market with clever predictions, but the reality is often humbling. Accepting that we can't predict the future can be liberating. It allows us to focus on what we can control, build a diversified portfolio based on sound principles, and tune out the annual cacophony of predictions.