Future of Forecasts

‘Tis the season for predictions. Pundits offer conjectures on every conceivable subject, though accumulating evidence in recent years has established, as much as anything can be established, that you might as well examine tea leaves to divine the future. Yet one could learn from prophesies; a few are thought provoking and some may even be true.

My favorite is a little gem attributed to J.P. Morgan (JPM), the man who gave his name to the bank. I’ve heard this quote from financial industry people but don’t know the source.  Asked how markets will do, J.P. Morgan is said to have replied: Expect markets to fluctuate.

As a supposed insight, this appears to be worthless. What can you do with it? Had he instead said, “Expect company X to go up 20%,” well, you could buy company X. Except that there would be no point—he could just as well be wrong and, more importantly, by the time you see the prediction in the news, it would already be factored into the price of company X. Information has to be exclusive to make money.

Hence our august Congress is careful with a proposed stock trading rule for its members, casting the net sufficiently narrow so as to allow members to continue trading on non-public information that arises in Congress.  Jonathan Macey, a law professor at Yale, writes in the Wall Street Journal about this bill: “On closer examination, it appears that what Congress really wants is to keep making the big bucks that come from trading on inside information but to trick those outside of the Beltway into believing they are doing something about this corruption.” By contrast, hedge fund managers and others face lengthy prison terms for trading on corporate information.

Going back to J.P. Morgan’s maxim, it tells us that markets don’t stand still. This is perfectly correct. Stock prices may move a little or a lot, but they do fluctuate. The saying contains another lesson—if everybody knows that a statement about the future is correct, then it is not useful. That the sun will rise every morning in the coming year is a most uninteresting prediction.

But if we don’t know whether a forecast is correct, then it is dangerous to act on it. Either way, trying to gaze into a metaphorical crystal ball must be a waste of time. Then again, there are exceptions.

A seminal work in the debunking of futurists is Philip Tetlock’s 2005 book, Expert Political Judgment: How Good Is It? How Can We Know? Tetlock studied hundreds of experts’ opinions on economic and political events and found that a “a dart-throwing chimpanzee” would have done better.

On the other hand, short-term weather forecasts turn out to be mostly accurate. It makes sense to take an umbrella when the forecast is rain. Moreover, weather forecasts have improved over time. The other hopeful sign is that we’re learning not to trust expert opinion outside certain areas like the weather. It is a good guess we will learn more in 2012.

• Become A Funded Futures Trader