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The Fallacy Of Predictability

 April 11, 2012 09:32 AM


By Darrel Whitten
After
each market crash or major economic recovery/bull market there are inevitably many so-called gurus claiming that they got it right, i.e., "called" the market or forecast the economy correctly. Research departments of sell-side and buy-side financial firms as well as independent forecasting firms all tout their "accurate calls". But as MarketWatch.com's Paul Farrell pointed out, the investment research and economic forecasting industry is built on a huge fallacy, which is the myth that mere humans can predict the future with any sort of consistent accuracy. 

Farrell quotes Brandeis University's International Business School professor William Sherden's research; "The Fortune Sellers: The Big Business of Buying and Selling Predictions:" Professor Sherden's 10 findings shoot the myth that any forecaster has a clue about the future.
  • No better than guessing: The forecasting skill of economists is on average about as good as guessing. Even the predictions from the President's Council of Economic Advisors, the Federal Reserve Board and Congressional Budget Office are often worse than guessing.
  • No long-term accuracy: Forecasting accuracy declines with longer lead times. 
  • Cannot predict turning points: Economists cannot predict turning points in the economy. In fact, the vast majority of all long-term predictions fail. 
  • No leading forecasters: No particular forecasters consistently led in accuracy. 
  • No forecaster was better with specific statistics: No economic forecaster has consistently higher forecasting skills predicting any one economic statistic. 
  • No one ideology was better : No ideology consistently produced superior forecasts.
  • Consensus forecasts do not improve accuracy: (but the press still loves them!) 
  • Psychological bias distorts forecasters and forecasts: Some economists are naturally optimistic and bullish. Others are consistently pessimistic bears. Their inner mental biases and ideologies distort their research, data selection, predictions. 
  • Increased sophistication does not improve accuracy: New technologies, algorithms, computer models of the economy can make forecasts worse.

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