Monday, January 10, 2011

"Predicting is Very Difficult, Especially if It's About the Future"*

*Nils Bohr, Nobel laureate in Physics

The beginning of each year brings a flurry of forecasts and outlooks. This year has been no different.

For example, based on my unscientific survey, most seem to feel that everything in the markets will be higher a year from now: interest rates, stocks, etc. Moreover, most of the folks making these pronouncements are pretty smart people, with impressive credentials.

Now, it may very well turn out that all of these will indeed occur. However, what if they're wrong?

This was the topic of a column in yesterday's New York Times. It is well worth reading if only to remind yourself of the unreliability of forecasting.

For example, just look at the opening paragraph - sounds very familiar to what most are saying right now:

IT was such a comforting forecast: By the end of the calendar year, a steady stream of corporate profits would extend the stock market’s long-term rally, raising the Standard & Poor’s 500-stock index by more than 12 percent, plus dividends.

Taking Market Forecasts With Many Grains of Salt -

But, as the author Jeffrey Sommer notes, here's what happened:

{The forecast} came at the very beginning of 2008. In January of that year, the future, as seen by the professional soothsayers, was about as rosy as could be. But it was completely wrong.

As it turned out, 2008 was a catastrophe — engulfing investors in the worst financial crisis since the Great Depression. But based on the numbers compiled in a Bloomberg survey at the beginning of that year, not a single analyst had even the slightest inkling of the dire events that were about to transpire.

None predicted, for example, that by year-end, the market would fall. Yet its actual decline was breathtaking: roughly 38 percent. Investors who relied on the consensus outlook endured one of the worst debacles in modern history.

Mind you, I'm not saying that we're heading for a repeat of 2008. However, it seems to me to be useful to consider all types of different scenarios when considering investment alternatives simply because forecasts can be notoriously unreliable.