Monday, November 24, 2014

"Thinking Clearly About Forecasting"

James Picerno writing at The Capital Spectator:
There’s a pernicious rumor making the rounds that economic and market forecasts are accurate. There’s also a misguided notion embraced in some corners that all predictions are worthless at all times under all conditions. Both of these extreme views are unproductive, bordering on dangerous. Yes, peering into the future is hazardous work and it’s a field that’s burdened with an excess of landmines. But avoiding what can be a nasty business is impossible when it comes to the money game. Thinking clearly about forecasting, as a result, is crucial. Unfortunately, a sober-minded perspective on this hot-button topic seems to be the exception to the rule in a world that’s awash with projections.

There’s a fine line between prudent and reckless behavior with generating and consuming predictions. Defining one vs. the other can be tricky at times. It’s even tougher to steer a middle course between those two extremes, in part because we’re all bombarded with a mix of useful and not-so-useful predictions on a daily basis. With that in mind, what follows are some thoughts on how to manage expectations on matters of prognosticating, guesstimating, and otherwise developing a healthy relationship with a treacherous subject. The list is hardly definitive, but it’s a start, if only as a reminder that predictions typically don’t come with instructions.

1. Recognize the inevitable. Imagining yourself as immune to forecasting is the equivalent of thinking that you can live without breathing. Everyone is swayed by predictions of one form or another, and by necessity. We all need guidance about the morrow, and for good reason: that’s where we’ll spend the rest of our lives. Some folks like to assume otherwise. Even a dyed-in-the-wool passive investor with a strict buy-and-hold investment regimen relies on an assumption — a forecast. An investment, regardless of time horizon, is at its core a prediction. Whether you’re buying shares as a short-term speculation or on the basis of a 30-year outlook, you’re making a bet that a transaction today will yield a profit tomorrow. How do you know that you’ll end up in the black? You don’t, but your forecast gives you confidence that you’ll triumph. You may be wrong, of course — in fact, you can count on no less, at least some of the time. But there’s no alternative. Investing sans forecasting is a conflict with no solution. A similar rule applies to macro, starting with the big-picture view that economic growth will, through time, endure, albeit punctuated with bouts of volatility. How do we know that such a future awaits? We don’t, but we have a forecast....

We have so many posts on forecasting, from ""How To Win At Forecasting" (Philip Tetlock and the Intelligence Advanced Research Projects Agency)" to "Pseudo-Mathematics and Financial Charlatanism...." that it is probably easier to just give gentle-yet-wary reader a couple searches of the blog:

Google site search: forecasting
Search blog box, above left