Tuesday, September 25, 2018

"Market Forecasting: A Sensitive Practice at the Heart of Neoliberal Capitalism"

HT up front: Professor Pasquale who quotes:
“In the absence of theoretical and empirical justifications, analysts base their work on what they refer to as ‘market feeling’ – a technique that builds of affect, tacit knowledge, and experience – to make sense of market developments.”
Combine that intro with an Alfred Cowles reference in the second paragraph and I'm in.
(actually the 'absence of theoretical and empirical justifications' line would have been enough, Cowles is the cherry on top)  

From Economic Sociology and Political Economy (emphasis in original):
Since the emergence of modern financial markets, financial analysts have played a critical role in producing visions of “the economy” and its future development. As experts, they analyze market developments and predict future scenarios that enable other financial market participants to speculate on the rise or fall of stock prices, the success or failure of particular investment products, and the growth or decline of entire national economies. The substance of the analysts’ valuation and forecasting practices is, however, heavily disputed among economists. In neoclassical economic theory, the assumption that markets are informationally efficient has challenged the legitimacy of the work of financial analysts since the establishment of the efficient market hypothesis as a central paradigm in the mid 1960s. Alternative schools of thoughts – such as new institutional or behavioral economics – have criticized this paradigm. However, they have also argued that the degree of uncertainty, which is inherent to financial markets, makes prediction impossible.
Empirically, this critique has been around even longer. In 1933, economist Alfred Cowles published an article that tested the attempt to forecast stock market prices. After having analyzed thousands of stock market predictions from 16 financial service agencies, Cowles came to the conclusion that “[s]tatistical tests of the best individual records failed to demonstrate that they exhibited skill, and indicated that they more probably were results of chance.” Such results have been confirmed repeatedly. In the UK in 2012, for example, Orlando, a ginger cat that tapped over the pages of the Financial Times to select stocks, outperformed a group of financial professionals.
The lack of justification of the forecasting practices financial analysts deploy brings up an important question: Why do financial analysts exist at all? How do they manage to maintain their role as experts in the market? And how they cope with the uncertainty and lack of theoretical and empirical foundations of their practices?

I spend two years in the financial analysis department of an internationally operating bank, where I was given research permission to follow the financial analysts’ work practices on a daily basis. In my book
Stories of Capitalism: Inside the Role of Financial Analysts (University of Chicago Press, 2018), I illustrate how, in the absence of theoretical and empirical justifications, analysts base their work on what they refer to as “market feeling – a technique that builds of affect, tacit knowledge, and experience – to make sense of market developments.

In the first weeks of my fieldwork, a financial analyst who coached me, told me how I could learn to do financial analysis. He advised me to take some time getting a “feeling” for how markets work. “This takes a lot of time,” he explained, “but basically, you just have to observe the market and read financial newspapers and the reports of other analysts.” The analyst then stared off into space, groping for words. After a while, he said, “You know, it’s not just about observing and reading, it’s about…” He did not finish his sentence since he could not put into words how one should develop that feeling for the market he was talking about. “You know, it’s about…,” he made a gesture as if he was touching a very smooth fabric to check whether it was made of silk. “That feeling,” he continued, “is what differentiates a good analyst from a bad one.”

Weeks later, another analyst allowed me to sit next to him when he valuated a company’s stock in order to come up with a forecast. To come up with a company’s “target price,” that is an estimated future price of a stock, this analyst first looked at the facts and figures presented in the company’s quarterly financial statements. After looking at the numbers depicted on the statement, he entered them into the bank’s internal computer program. He was, however, not happy with the target prices proposed to him by the models he used. He looked at them and then told me that the numbers support his overall feeling. Looking at the numbers a second time, he sighed, turned to me, and said, “You know what, I’ll take the most bullish target price and adjust the projections on the overall market development a little. After that, I’ll have a target price that truly reflects my feeling about the future development of this particularly promising stock.”

Combining such market feeling with calculative practices allows financial analysts to create persuasive narratives of the future of the market. These narratives become visible in the way analysts explain future market developments. Moreover, they are inscribed into the aesthetics of charts, tables, and figures analysts produce to visualize past, current and potential future market developments. Once these narratives are created, they are circulated among the banks’ stakeholders and clients. Sometimes, the narratives also become part of broader public discourse – often through the help of newspapers and TV stations that give financial analysts a platform to share their opinions on economic developments....

I've mentioned that we are rather fond of Yale's Robert Shiller. He seems to have "a pretty good feel" (see above) for this stuff. Here's his September 4, 2007 call:
Some U.S. Housing Markets could drop 50%- Shiller

In addition to publishing "Irrational Exuberance" in March, 2000 with the NASDAQ hitting its then-all time closing high of 5048 (subsequent low 1114, how's a 78% decline grab ya?) he is the keeper of the Cowles Commission records. From one of our Forecasting Equity Returns posts:
A subject near and dear to my heart. I may be the only person I've ever met who read every page of "The Cowles Commission's Common Stock Indexes 1871-1937".
[you must be a blast at parties -ed]
Well, in addition to Common Stock Indexes  we've posted some of Cowles' other stuff including a quick hit in January 2008, after the August 'ought-seven' quant-quake but before things got really ugly in September '08:

"Can Stock Market Forecasters Forecast?" is the title of a paper by one of my heroes, Alfred Cowles III.

It appeared in Vol.1, No. 3 of Econometrica, after having been read to a joint meeting of the Econometric Society and the American Statistical Society.

Mr. Cowles answer to the question?
"It is doubtful."
December 31, 1932.

[this is also the paper linked in the body of the ES&PE story but our link went to an ungated version, should one be inclined to peruse]

I'll have more on Mr. Cowles work later today. In the meantime, here's The Cowles Foundation for Research in Economics at Yale University.
The Cowles Foundation continues the work of the Cowles Commission for Research in Economics, founded in 1932 by Alfred Cowles at Colorado Springs. The Commission moved to Chicago in 1939 and was affiliated with the University of Chicago until 1955. In 1955 the professional research staff of the Commission accepted appointments at Yale and, along with other members of the Yale Department of Economics, formed the research staff of the newly established Cowles Foundation.