I’m confused by a lot of things in investing, but the enduring influence of market forecasts is the one that stumps me the most. Year after year, expert predictions, estimates, forecasts and projections prove to be profoundly wrong. And yet next year we seek them out again. It’s like repeatedly pounding your thumb with a hammer and expecting that at some point it will stop hurting.
One of the reasons we still listen to forecasts is that the media love to celebrate the few that turn out to be right. Those that are wrong—which are the vast majority—are rarely held accountable.
With that in mind, I thought it would be interesting to look at the 2011 Fearless Forecast, the latest edition of a report published for 20 years by Mercer. The Fearless Forecast compiles the consensus opinions of Canadian and global investment managers regarding the capital markets and the economy. The 2011 edition included input from 56 investment management firms, including some of the most prestigious asset managers in the world.
The last shall be first, and the first shall be last
The managers were asked to identify which asset classes they believed would be among the top and bottom performers in 2011. The most popular picks in each category are listed below, along with the percentage of managers who predicted that asset class would be among the best three and worst three performers. Where it was available, I’ve also included their average estimate for the returns of that asset class, followed by the actual index return for 2011.
|Emerging market equities||63%||4%||10.6%||-16.3%|
|Canadian long-term bonds||4%||66%||0.1%||18.1%|
It should be clear from the above table that the forecasts were not merely useless: they were spectacularly harmful to anyone who acted on them. An investor who followed these consensus opinions would have been slaughtered in 2011. They would have been helpful only to the strict contrarian: if you shorted all of the top picks and leveraged all of the bottom picks you would have made out like a bandit.
Dissecting the sectors
Let’s go one level deeper and see how the experts made out when forecasting the performance of individual sectors of the Canadian economy. After all, active managers know when to get defensive during difficult markets, right?
Below is the percentage of managers who picked each sector as one of the best or worst performers, along with the actual 2011 return for that sector. (I was not able to find index data for the other four sectors—industrials, consumer discretionary, telecom and health care—but none of these make up more than 6% of the economy.)
The message here is not that these investment managers are fools. On the contrary, the participants in this survey are among the smartest folks around. They have a deep understanding of the markets, and access to more data than you and I will ever have. The point is that their superior knowledge and skill give them absolutely zero ability to predict what’s ahead. Their predictions were far worse than you would expect from random chance.
Human beings take comfort in forecasts because we detest uncertainty. But if you’re going to be a long term investor, you need accept that uncertainty is part of the deal. Since we can never be sure of what lies ahead, the most prudent strategy is to diversify.
All of the asset classes in the table above have positive long-term expected returns, but all of them will behave unpredictably over the short term. Rather than engaging in the futile attempt to guess next year’s winners and losers, hold all of them in your portfolio all the time. Rebalance once or twice a year. And make a pact never to listen to market forecasts again.
H&R Block tax software winners
Thanks to everyone who entered the draw for the H&R Block tax software. The five lucky winners are Michel, Mike, CCP Fan, Aziz and Rick. I will contact the winners by email to make arrangements.