Why are forecasters so often wrong?
This week RBS has forecast an equity and credit crash within three months. It is unusual to get a direct warning from a major bank. Who forecast a UK housing crash last August when the sub-prime crisis hit? Nobody in my recollection and yet you could see estate agents sitting idle in empty offices. I think it all down to herd instinct and the madness of crowds.
The French psychologist Gustave Le Bon wrote about how consciousness about our actions diminishes in crowds until one hundred people behave like a complete block head.
And if you look at herds of wildebeest on the Serengeti plains you can see this in nature, and crowding together does give some defense against lions, although not much if you step out of line. Being a part of the crowd means analysts can avoid ridicule when wrong and enjoy the warmth of success with their friends if proved right.
But the problem is that crowd psychology dulls the senses which are all that an analyst has to live by. That means going over the cliff with the rest of the lemmings when the error becomes obvious.
Take UK housing last summer. I was as guilty as anybody in having proclaimed the end was nigh and been wrong for a couple of years, I had just shut up. Nobody in the crowd wanted to hear my warnings any more. But I at least behaved rationally enough not to buy a house and persuaded my mother to sell her investment property.
You get few prizes for being right, people only remember your bad calls, especially when being right means that they are wrong. It will be the same story with the stock market crash this autumn, or sooner, if RBS is right.
Bloomberg TV followed that story yesterday but dumbed down the conclusion in its headline so as to make it look as if RBS was merely making a below consensus forecast, and not highlighting the possibility of the end of the world as the financial community knows it. People don’t want to think it is possible, so even the financial journalists oblige and censor the nasty details.
So the crowd will plunge with the crash, and the lions will effectively get them all at the same time. My view as a contrarian investor and scourge of the efficient markets theory is that you will only ever achieve above average investment performance by betting against the crowd which has to be at best the average if you think about it.
Short positions against the S&P look an excellent idea in the current market line-up, and both precious metals and the dollar. For in a stock market crash then the flight to safe havens will benefit both, and unusually these two asset classes will both rise sharply in value together. But I am not sure about the bond market as inflation is rising so strongly around the world and a rout in the bond market looks inevitable as RBS suggests.
I have to say your logic has merit – houses do look fundamentally over-priced…like the Nasdaq in 2000 and where is that today? But this has very serious consequences for mortgage holders and mortgage providers – perhaps only hyper inflation will bail people out but property will still be a lot less valuable than it has been recently in relation to other assets.
peterjcooper
June 21, 2008 at 1:29 pm
@Leon Sincero..
The weather has nothing to do with emotions and the human greed factor, or it’s opposite – fear, so it’s less predictable! The reason markets, property, or anything else folk latch on to as an idea of getting rich, go up and down is because they are steered by these two emotions – NO MORE, NO LESS. The weather, and what you eat in 11 days time, isn’t (other than hunger). The Moon runs through cycles, we have seasons, and women have their cycles of 29.5 days. Ever watch a tide go in and out? These aren’t emotions, granted, but they are cycles, just like the time you generally eat during the day, and to a lesser extent what you eat; you are born, and you die. It’s all cyclical and many, many, many cycles can be predicted just by watching the habits of their causes……It wasn’t so far back in time that people thought that getting into tulips was the best investment since investing (Wiki on the “Tulip Mania” for a brief recap) and history is littered with on-going similarities – perhaps this is why the RBS has made the call?
Unfortunately for the masses, most don’t understand statistics or the Laws of Probability, or even their own emotions and fears (now ask yourself why the financial sector is in a mess – did emotions get the better of them?). I’d suggest that if you are in a field surround by the enemy, you’d have a pretty good idea and feel for your chances. The RBS is in the field of fire……along with the rest of the financial sector (and the attached sectors…which encompasses virtually everything!) – but now I’m getting Fundamental.
@peterjcooper:
….you’re a journalist, a commentator. Perhaps a more technical approach to property would have you “wondering” if we have just seen wave 5 of the last property bull run (typified by the classic parabolic curve, to boot). I’ve already touched on some of the fundamentals that face us in the future, not least in property – and this isn’t a forecast, it’s fact. The demographic time bomb is ticking…..and let’s face it, dead baby boomers don’t need property. So, who will take up this slack in the soon to come, over-supplied property market? The mere fact that Gordon Brown enabled property to be within a Pension Plan is reason alone not to do it – he doesn’t understand markets…..otherwise he wouldn’t have sold gold at a cycle low – when inflation too was at it’s cycle low (gold being the hedge against inflation, so the two go hand in hand). Interestingly, the inflation cycle is only now kicking in, and these cycles generally last 20-25 years, give or take. This puts us right in the parking zone when the baby boomers want to sell their properties, and even when the early boomers begin to die off. Inflation hits people’s pockets and limits their propensity to spend, and this includes spending on property. Yes, we are making similar calls to the downside, and there is a risk of consensus, however, you are still being guided by habit and your emotional connection to property…..otherwise you wouldn’t say that property will recover. And this is where we part company in our views. Any recovery (nothing goes up, or down in a straight line), will only be a dead-cat bounce. If we have just witnessed the peak of a wave 5 up, as typified by the parabolic nature of the curve, the correction will be nasty, very nasty – never before seen in history nasty, the same way the never before seen in history baby boomers die and leave their property vacant. Even the Fundamentalists know, too much supply and too little demand has it’s consequences (just look at the US $), it’s just that they haven’t smelt the coffee yet. A perfect scenario for a 5 wave down cycle that will likely last for decades and decades.
I you were 25 years old and born on Mars, you’d never be aware that there was a winter. Like my father, he believes the property market will keep on going because in his life time, he’s seen nothing different. Some cycles are so long most people aren’t even aware of them. In fact, most can’t even see the short ones, so caught up are they in their emotions and indeed, ignorance.
From an American context, property wise, the fall in the value of the dollar is masking the true extent of the housing collapse. In comparative terms, in May 2005 a home would typically fetch 490 ounces of gold. By January 2008 its value had fallen to only 212 ounces of gold. That’s a spectacular 56% decline in the value of the American home in 2 1/2 years when measured in gold, a traditional store of value.
With 70% of money in global reserves being the US $, there’s a lot of wealth being eroded, and this will have it’s consequences…and it is having it’s consequences.
Who needs forecasters anyway?
Prudent Bear
June 21, 2008 at 12:55 pm
Market price moves depend on the aggregate decision of thousands (millions?) of individual investors with small amounts and of relatively few investors with large amounts.
What makes anyone at RBS or elsewhere so sure where the market is headed in the short term? or how strong the movement will be?
Plus, weather forecasts are generally considered the most “accurate”, but only for 3 or 4 days in advance. The weather forecasts in Montreal for every day of the past week were “sunny with a 60% chance of thunderstorms”. There’ll likely be one eventually, but still no thunderstorms yet…
Accurately forecasting what one will be having for dinner in 11 days is tough enough, let alone what a whole market will be doing in the near term.
LS
Leon Sincero
June 20, 2008 at 11:37 pm
“This isn’t the beginning of the end, but merely the end of the beginning.”
Dear Prudent Bear.
No.
This is the end of the end.
This is the end of economics based on growth as we know it, the end of the $ as the world currency, the end of oil as the source of US global hegemony, the end of oil as an exported commodity as producers hoard, and on, and on.
Demand destruction, nation destruction.
But first, – more war!
A new beginning is not yet on the horizon.
Politicians and global think tanks, with their heads firmly jammed behind their sphincter muscle, have yet to realize a new paradigm is needed.
And before one is acceptable to all, we have to go through the parades and the posturing and the threats, and the pork barrel and the promotion of interests, and yada, yada.
And all the time this is happening, nations will quietly pursue their own agenda, and the Energy [OIL] required to make global modifications to infrastructure will be being wasting away.
I
June 19, 2008 at 7:05 pm
Not sure which of us forecast the 60% decline first, see: http://arabianmoney.net/2008/04/03/uk-housing-slump-to-be-worse-than-1991-3/
There is a danger of forming a consensus on this! But I do think you need to be a contrarian to sell out before the crowd does – however, just doing the opposite all the time would be equally hopeless.
peterjcooper
June 19, 2008 at 5:01 pm
Would anyone like to buy a tulip from me for 200 dollars? No reasonable offer refused.
I remember my father saying to me decades ago and oft repeated, that property was a safe bet. Over the long term, any periodic downward moves would be more than recovered by future gains. He would say that. He also said the same about shares. Only if you bought an index 10 years ago, would you have made money if you sold today? Most importantly, if you continue to hold your stock, can you be sure that you will be back in profit in the next 10 years? Here’s my forecast – forget it!
He’s experienced the consequences of population UK going from 10 million to 60 million plus in 200 years. Global population has doubled since 1969. He has never lived during a time when much needed resources were running out, including food, water and energy, nor has he experienced the ensuing consequences of human induced global warming. If this isn’t inflation, then what is? Putting up interest rates to stop inflation, or even just to cool it down a bit, is much akin to using a chocolate tea pot in this New Era. This is a new experience to everyone. And growing more tulips won’t bring prices down, because we are fresh out of fields to grow them in.
The credit crunch and whatever current flavour-of-the-month trendy term one cares to express, isn’t a cause, it’s a symptom. It’s a symptom of many ills that are now coming home to roost.
Sooner or later, governments will have to realise that sustainable growth isn’t sustainable. It’s not sustainable because the basis on which capitalism is founded, was based on eternal resource availability. Supply and demand, however, is a factor of need, greed, or both, and will therefore prevail until we burn out completely. Population growth is a need of governments and economies simply because it provides new markets as well as paying for the retirement and health care of the aged (and boy, we have a lot of aged coming through with the baby boomer epidemic). But we are now entering a time when we are unable to feed the new populations, let alone existing ones. Indeed, we are entering a time when we can’t even afford to have children. So, who will be buying all that property we’ve been putting up since 1969 to satisfy a doubling of population? Chindians?
You can put up interest rates all you want to try and stop people from buying food, or for fueling their car but the consequence will be to the economy. The UK has the highest debt ratio’s in history (no doubt because the number of people in the UK is the highest in history!), and the reality of negative equity is only just sinking in to those numb skulls.
Call me perverse, but I was grinning the other day, amused while listening to people being interviewed on TV. They were apparently having difficulty raising finance for a mortgage. Perhaps one of those interviewed would like to buy my tulip instead – it’s a fantastic investment….and if you miss out buying it today, you won’t be rich and wealthy, because you won’t be able to sell it tomorrow for a higher price.
Going with the masses isn’t foolish, however not knowing when it’s time to get out certainly is. But sadly, we aren’t educated at school to be able to make such rational decisions or judgments. Instead we are educated to get a job, and to work, and to be ignorant. Perhaps this is why forecasters get it wrong? Because, just like Gordon Brown, they too don’t understand what’s going on around them. Brown, by the way, sold most of Britain’s gold reserves when valuations were at a historic low, and, incidentally, not much higher than the price it cost to mine the stuff. He looks stupid because he is stupid. If he understood market dynamics and cycles, he’d have known that instead of selling it, he should have been buying more. At least by now, the country would be sitting on an asset instead of a liability. Tax receipts cannot be reduced but actually need increasing to fund the gap in the accounts. Look out, massive job losses are on their way…..
Interest rates weren’t raised because of the stress it would have put on borrowers. One way or another, the train is heading for the end of the rails. There is only one solution – suffer the correction, get it out of the way, then move on. One thing history is repeating, is that cycles are unstoppable, just like the cycles of human greed….. and fear that actually cause them. Finally, wasn’t it the Labour government in the UK that wanted to put an end to boom and bust cycles? Ultimately, they have helped boost the epidemic of inflation by massive public spending. However, beyond all this are the externalities of global events and of other cycles, some of which are in evidence, and some are not because of the speed at which they progress (or regress); so slow to be unrecognisable.
My father will just begin to see that the cycle of ever-ending upward prices for property, is now over (as the long cycle now corrects). There might be a final fling, as those i mentioned earlier in the TV interview actually manage to get some money from somewhere and buy-in when they think the market has bottomed. However, nothing goes up, or down, in a straight line. Only the fools get dragged in hoping for the upward cycle to continue. And when it turns and goes back down……so on, and so forth. This will have a consequence far bigger than even the RBS has predicted and which the Bank of England has only just touched on (albeit too little of a warning, and too late). Like the star ship Enterprise, we are “…going where no man has gone before.”. This isn’t the beginning of the end, but merely the end of the beginning.
Being a contrarian investor and going against the masses for the sake of it isn’t smart, but knowing which horse to back and when, most certainly is. Going with the masses can be very rewarding, simply because of the momentum they create. Just push the sell button at the right time, eh? But doesn’t this rule apply to any investing, contrarian or otherwise?
Finally, i will mention pyramids. At the top of the pyramid you have the very wealthy few. The pyramid gets bigger as you get towards the bottom, where it represents the poorest. Good forecasters are likewise at the top of the pyramid, bad forecasters (the many) are at the bottom. It’s a matter of statistics; not everyone is smart because not everyone can be. It’s the same for financial advisers too. You won’t find many good ones, because statistically they don’t exist in big numbers. Bad ones do, however!
I think my tulip needs watering…..I must keep it looking good for the next buyer. By the way, i’m forecasting a decline in the UK property market of 60 percent minimum during this phase. Forget not that it won’t be reached in a straight line. And you get this for free!!! Now am I being serious?
Prudent Bear
June 19, 2008 at 4:47 pm
Yup!
I
June 19, 2008 at 3:09 pm
It would only be a short-term rally, like so many before, in the long-term dollar decline…
peterjcooper
June 19, 2008 at 3:01 pm
Peter.
You changed your view on a toasted $ upcoming?
I
June 19, 2008 at 2:51 pm
Neverthelesss, a GREAT book: The Crowd by Le Bon.
Luitenant
June 19, 2008 at 2:12 pm
Nothing to do with herd instinct.
Most anal-ysts are employed by financial institutions whose interests are not best served by their advisory clients knowing too much, particularly in these times, ie, they would exit, lucrative fees would be lost.
Hence the oft repeated calls, “the bottom is in” to sucker in more suckers, to facilitate a more profitable exit for themselves.
Notice how the AAA rating on monolines was only downgraded when their shares were worthless, ie, all the institutional money had departed?
The criminal scum are well able to read the runes, they are just not going to tell the truth, they need bag holders to smooth their own exit.
Notice how no-one is talking about the upcoming muni-bond fiasco in the US. Or the upcoming 100s of smaller bank wipe-outs.
Notice how the MSM in the UK is playing the political moves on the independence of the B of E.
Notice how the MSM in the UK is playing yesterdays ratification of the lisbon treaty.
Everybody who has a megaphone lies!
I
June 19, 2008 at 1:29 pm