More Meaningless Predictions for 2013?

Location Date: 
January 2, 2013

As we finish another year, lovers of all social sciences gather round the tree of life to prognosticate on what is in store for 2013. Have you ever asked yourself why we find these predictions so popular? As always, I turn to my favourite economist of all time, Daniel Kahneman. He says blame your mind's System 1 or that part of your brain that operates automatically and quickly with little or no effort. Your analytic System 2 requires effort, self control and concentration to make decisions. Unfortunately, by nature, it is lazy! Forecasts are easy to enjoy—they "compress a vast amount of expertise and analysis into a few words",1 and since they come from an 'expert' we can skip intense thought and just take in the profound meaning. Of course, there are no shortage of experts making a living offering up their profoundness. This fact stems from what Kahneman calls the illusion of validity—"the illusion that we understand the past fosters over confidence in our ability to predict the future";2 everything in hindsight makes perfect sense. Using the tale of "The Hedgehog and the Fox", he describes hedgehogs as those with a sophisticated explanatory framework or model that spits out forecasts (like the FED's FRB U.S. model I mentioned in my last post — Click here to read).

Of course, when it is wrong, they will not admit to it—maybe they were just early or maybe some 1 in a billion thing came along to upset things. The fox, on the other hand, recognizes that "reality emerges from the interactions of many different agents and forces, including blind luck, often producing large and unpredictable outcomes".3 Guess which persona the media loves? Especially when you can get 2 'experts' together with completely different forecasts—in CNBC terms, this is like Peter Schiff versus James Paulson or better yet Rick Santelli versus Steve Liesman. 

Voila—you have great TV, which is both profound and quick and easy, so they get to another commercial. Needless to say, the poor fox types make for horrible TV, but they are people you most likely will want to invest with or follow.

Looking at Wall Street strategists today they remain quite bearish; for all the known reasons as they did in 2012. Contrarians will delight in this as the direction for equities is then likely up. Most strategists tend to just follow the trend—so because equities were higher in 2012, they were less bearish than previously. This analysis is not worth much. I prefer and do enjoy reading the more outrageous investment predictions based on supposedly improbable scenarios. I have mentioned previously Saxo Bank's list as a good example (Click here for their latest), and now the folks at DB, Morgan Stanley and others have gotten into the game. And of course, you cannot forget to check out Blackstone's Byron Wein's Ten Surprises (Click here to view). The world appears to be one screwed up place right now so many of the outliers mentioned in these reports are worth more than a passing thought. These all deal with 'known unknowns' but not Taleb's Black Swans. Still, reviewing the 'what ifs' and non-consensus views helps in mitigating risk to some extent by refining our probabilities when investing and trading. From a more micro standpoint, I also enjoy reading the top 10 lists put out by the World Future Society and other technology related pundits—but even here it is really difficult; for example, nobody truly predicted the meteoric rise of tablets (save for one). But still there are plenty of interesting ideas and trends to watch for in an attempt to earn a return. 

On behalf of everyone at Arrow Capital, best wishes for a happy, healthy and prosperous New Year. And may the 'unknown unknowns' go your way! I will post my less-than serious forecasts for 2013 shortly.

Jim McGovern 

1. Financial Times, December 28, 2012, "An insatiable desire to read into the future", Tim Harford
2. Kahneman, Daniel; "Thinking, Fast and Slow", page 218
3. Ibid, page 220