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The Scandal Of Prediction

From Don Nalls,
The Nalls Sherbakoff Group, LLC.

Dear Friends,

If you are remotely interested in the stock market, chances are your email is filling up with mid-year stock and market forecasts. These are the same prognosticators that misread the impact of Covid-19, the subsequent market sell off, and the stunning recovery in the 2nd Quarter in the first half of 2020. One could reasonably ask, “why do so many investors heed these folks’ recommendations?”

A number of years ago I gave a talk to the local Society of CPA’s. These professionals had a lot of cognitive bias and believed two fictions about investing:

1) Many, but not all, thought they could pick stocks.

2) As a corollary, that they could also predict future trends. 

As part of the presentation, I had a whole section of my PowerPoint® titled the “The Dismal Record of Expert Prediction.” A number of years before my talk I had stumbled on a set of predictions, put together by the famous RAND Corporation, from 1964, by something like 84 experts (they were experts: all the predictions were done by medical leaders, professors — aerospace engineers, nuclear physicists, etc.) By 1995 we were supposed to be mining minerals on the moon; have started our first colony on Mars, and cured cancer. The predictions, by these great and good men (mostly men as it was 1964) were so startlingly bad, that I became a life-long student of the “science” of predictions. My subsequent study has reinforced that no one is good at predicting the future; in fact, we humans, no matter how well educated, are simply terrible at predicting. The only real difference is that some of us know we are terrible at it and most do not.

No group of intellectuals have done more to put the knife in predicting than Philip Tetlock, Daniel Kahneman, and Nassim Taleb. Nassim Taleb, is one of my favorite authors/maths prodigy/professor of statistics. I am a huge fan of his books, especially, Fooled by Randomness and The Black Swan. The Black Swan is especially good reading right now. From that book, Taleb notes our need to construct and to believe narratives from the past. That system makes it near impossible for humans to accept the limits of our forecasting ability. Taleb’s analysis demonstrates that success in forecasting is often just simply luck!  For example, the brilliant founders of Google were ready to sell Google one year after they started it, but the buyer said the price of one million dollars was too high. They were lucky the buyer thought the price too high; if not, they would not now be as rich as they are. (BTW: luck as part of a process is not just limited to Google: it’s also true for Microsoft and Apple). As Taleb demonstrated, we hate taking luck into our calculus. The great and the good don’t need luck. And it flies in the face of another cherished belief, that the world makes sense. This belief rests on a strong human behavioral foundation – our almost unshakable ability to ignore our ignorance as a species. 

The last book I strongly recommend is Philip Tetlock’s, Super Forecasting: The Art and Science of Prediction. Tetlock is a psychologist at the University of Pennsylvania who has done multiple long-term studies on experts and prediction. In one study he interviewed 284 experts (once again “real” experts — leading medical professionals; economists; political scientists — not ordinary guys like me); he tracked their predictions over 20 years (some 80,000 predictions!) and to quote:
 “The results were devastating. The experts performed worse than they would have if they had simply assigned equal probabilities to each of the three potential outcomes. In other words, people who spend their time, and earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options.”     
Kahneman, in particular, believes that Tetlock’s work should put an end to all the forecasting “experts” but he’s too smart of a psychologist to really believe that. 

Devastating is the word, indeed, dart-throwing monkeys would have done better. The good news is that all the research conducted since 1965 (using data that goes back at least 6 decades) demonstrate no matter what the technological, economic and political disruptions, the dimensions of expected return remain the same. Beta, small versus large, value, and profitability continue to drive market returns. Therefore, to be a successful investor, all one needs to do is to understand personal risk tolerance; diversify to complement that risk tolerance, and most important of all, stay disciplined. Being able to read a crystal ball is not required, thank goodness. 


The Nalls Sherbakoff Group, LLC

DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal, or tax advice. The Nalls Sherbakoff Group, LLC makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of The Nalls Sherbakoff Group, LLC. Past performance does not guarantee future results.