Should we be forecasting at all?

Markets run on earnings is the commonly held dictum. The entire market, is therefore into forecasting what those earnings shall be. Numerous methods are used and practitioners of each of them claim that their approach is the best. Or it is the best they can do. After all, there has to be a ‘capability ‘to make forecasts. This so called capability is what creates jobs and businesses. Both jobs and businesses seek to satisfy the demand coming from the market place. And the demand is: what’s going to happen in the future?

We are all so obsessed with the future because thats where all our riches , we tell ourselves, lies, where they are to be found or even created. So the race is on to forecast. The next quarter, the next year, the next 5 years or for those looking at the shorter term, the next hour or next few minutes. Its all about what is going to happen next. Even those that speak about the next five years are not immune to what is going to happen next- they just pretend that it doesn’t matter.

So newer and newer methods are devised, older methods are re-jigged, technology is brought in to create tweaks and speed up the processing information. More and more data is looked at and linkages are created between data sets that were never thought of ever before. And because no one is quite sure about what is connected to what, no one questions these approaches. They just look at stuff that they think they are able to handle and perhaps do. So the larger the player you are, the more the data you can collect, bigger the data crunching you can do, in the hope that your output will be better than the next guy. You narrow it down to stuff like Value, valuation, earnings trajectory, visibility, reliability of the outputs etc. Etc. For the price guys it is price action and trends, more momentum indicators, more ways to measure and handle volatility. Finally its all about controlling risk and keeping it within a certain band and then program the machines to handle all this. Never mind those occasional flash crashes- they are just small glitches in the overall big structure, we tell ourselves, overlooking the fact that everytime something like that happens, it is like reaching 98 on the Snakes and Ladders game and getting bitten by the snake- to send you down to 11! But hey, you have your data crunching machines and associated nonsense to help you make it back to 98 again, right?

Data in India may be said to be quite limited and hence we do not have the kind of extensive ‘research ‘that the US analysts are able to put out. So, you would think the vastly greater amount of data that is available in the US ought to produce more reliable “forecasts”, right? That would be logical to think. But, pause here to take a look at this chart.

The bond markets are giants and the biggest banks and players are part of this market. So there is no dearth of ‘talent ‘, supposedly, in this space. Now take a look at the result of that talent pool in forecasting something as basic to their market as bond yields. Could something have been more off the mark?? I am sure the guy at the top end of that prediction for June is now out of his job!

Understand that the entire data has been assessed but some of the finest brains using the most sophisticated computers running the best of algorithms for the longest periods of time, cross checking on hundreds of combinations and possible outcome. After doing all that, we presume, the analysts came out with their forecast.

Doesn’t this really show that no one really knows anything, most of all, those are supposed to know? Where does that leave us all? Should we do this stuff at all? Is it all just some roll of the dice then? Are we all existing in this incredible make believe world of useless forecasting? Perhaps we are. But question is can we live without it?

Future is one big hope. All the things that are not in the present or that we wish were already there, are all hoped for in the future. I want to buy stocks where I am certain about the earnings and growth for the next 4 or 8 quarters. I want to know that today. Since that is not possible, the next best thing is to forecast it. This helps me to create an image of certainty, create a sense of comfort on what I am about to do and have a sense of security that I am not acting randomly. Forecasting is essential because we want the Ideal. Our actions are then directed to achieve this ideal. More, we want to mimic all those who are also engaged in the pursuit of the ideal. Rene Girard, the Stanford professor who champions contrarian thinking, calls this Mimetic behavior.

In the case of the bond yield forecast shown earlier, it is probably this mimetic behavior that’s at work. Analysts within the fraternity probably know each other and certainly follow each other’s work. The tendency towards mimetic behavior influences the way we think and once we find that the forecasts are all tending towards the positive, it is difficult to go against the grain. I recall a while ago giving a very contra, deeply bearish forecasts on Rel Com and Indiabull group and these guys were castigated for their blasphemy! No one believed those seeminly dire forecasts back then but subsequent price action has proved them correct. It was mimetic behavior back then and it is once again, mimetic behavior now that got us this yield forecast that has bombed across the board!

I myself am in the business of forecasting. Have been for decades. It has worked out ok but I am certain there are countless number of bombed forecasts that my mind would prefer not to remember! Like me, there are a thousand others who are also engaged in the business of forecasting. We are in the search for the ideal too- of being able to know what is going to unfold into the future and the way it is going to unfold as well. We are doing it for ourselves and for the sake of our clients who ask for such services (to satisfy their own search of the Ideal).

How do we ensure that we don’t become victims of our own forecasts or indeed fall victim to other’s forecasts (mimetic behavior)? For one thing, I would think that the more we desire an ideal outcome, the more is the tendency to believe and follow a forecast. So check on how badly do you want a certain outcome. That can be tempered thru other means and the problem can be reduced to an extent. In the markets, one of the maxims to follow was something stated by Robert Miner, a veteran market technical analyst. He said, Never trade a forecast, always trade the market. This single maxim, which I have made my own over the years, has prevented me from being ever caught in the tailspins of forecasts that the market can catch you with every now and then. The market is reality, our forecasts about it are expectations and therefore in our minds only! Follow reality, is what Miner is saying here!

Value investing is in fashion these days. This is one of the areas where mimetic behavior appears to be dominant. Buffet is a hero. There are many blind followers, who have also become a bit iconic and hence heroes for those lower down. This is a very two-dimensional world. There is the Hero and the Goal (the investing model) on one side and there is Obstacles (the market) on the other side. This is now made into a battle of the Hero (I.e. the Model) vs the Obstacle (I.e. the market). But reality is quite different from this fairy tale, two dimensional model. People’s emotions, random events, constant barrage of information, technology enablements are all new villains that create many more dimensions that take us out of the ideal two dimension setup where good (the Model) wins over the bad (the market). To win this, normal people fall back on what the Icons are saying (or forecasting!) and make it their own. Rakesh is still holding stock XX, they rationalize. Damani has bought trunkloads of stock YY, they justify- even as both stocks XX and YY are tanking way beyond what the normal investor can afford as risk. They overlook a simple fact that Rakesh or Damani have the means to hold those stocks into infinity because they have the money and it probably forms a very minor part of their whole portfolio. But for the normal investor, it is probably 10% or more of his portolio (after all, it was bought because of Rakesh and Damani!)

So, if we believe the Guardian model of human behavior, then a dose of Robert Miner practicality is the only solution in not getting trapped into something that we innately have to make forecasting but at the same time we have to protect ourselves against.