I ran across a wonderful review of Dan Gardner’s new book, Future Babble. He discusses why pundits make predictions, why people listen to them, and why you would ultimately be better off with a dart-throwing chimpanzee. The fact is that experts are terrible at predictions:
In Future Babble, Gardner acknowledges his debt to political scientist Phililp Tetlock, who set up a 20-year experiment in which he enrolled nearly 300 experts in politics. Tetlock then solicited thousands of predictions about the fates of scores of countries and later checked how well they did. Not so well. Tetlock concluded that most of his experts would have been beaten by “a dart-throwing chimpanzee.” Tetlock found that the experts wearing rose-tinted glasses “assigned probabilities of 65 percent to rosy scenarios that materialized only 15 percent of the time.” Doomsters did even worse: “They assigned probabilities of 70 percent to bleak scenarios that materialized only 12 percent of the time.”
Why, then, do people even listen?
Besides making fun of the failures of the prognosticating class, Gardner also explains why so many of us keep falling for false prophesy: Humans beings hate uncertainty. Gardner offers myriad insights from research in cognitive psychology and behavioral economics that explains how and why we succumb to our desires for certainty. “Whether sunny or bleak, convictions about the future satisfy the hunger for certainty,” writes Gardner. “We want to believe. And so we do.”
It’s fine, I suppose, if you listen to forecasts for entertainment. But knowing the track record of forecasters, why in the heck would you ever base your investment policy on a forecast? I’m not talking about just extreme forecasts like the rosy scenario or gloom-and-doom. A pie chart that allocates assets based on a forecast of expected returns and expected correlations is no less a forecast—and no more likely to be accurate.
An Expert Pondering His Next Move in the Market
Source: www.blingcheese.com
Just because we hunger for certainty doesn’t mean it is available. The only thing I can forecast with any certainty is that things will continue to change in unpredictable ways. Price represents a market’s best guess about what might happen down the road, rightly or wrongly. Price is an informed guess; people are putting real money on the line. Research shows that prediction markets are often more accurate than experts. Relative strength is just a handy way to measure price and gauge what market participants are doing. There’s no guarantee that they will do the same thing tomorrow, but perceptions generally change gradually over time as new information comes to light, or new thinking about old information emerges. Staying with strong relative strength trends and departing when they weaken is the simplest way to stay in synch with the changing flow of information in the market.
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