Swedroe: Grading The Forecasters

July 28, 2017

The financial media tends to focus much of its attention on stock market forecasts by so-called gurus. They do so because they know that it gets the investing public’s attention. Investors must believe such forecasts have value or they wouldn’t tune in. Nor would they subscribe to various investment newsletters or publications that, like some, claim to provide you with “news before the markets know.”

Unfortunately for investors, there’s a whole body of evidence demonstrating that market forecasts have no value (though they supply plenty of fodder for my blog)—their accuracy is no better than one would randomly expect.

For investors who haven’t learned that forecasts should only be considered entertainment (or that they may fall into the more nefarious category of what Jane Bryant Quinn called “investment porn”), they actually have negative value because forecasts can cause such investors to stray from well-developed plans.

Empirical Data On Forecasting
A new contribution to the evidence on the inability to forecast accurately comes from David Bailey, Jonathan Borwein, Amir Salehipour and Marcos Lopez de Prado, authors of the March 2017 study “Evaluation and Ranking of Market Forecasters.”

Their study covered 6,627 market forecasts (specifically for the S&P 500 Index) made by 68 forecasters who employed technical, fundamental and sentiment indicators. The sample period is 1998 through 2012.

Their methodology was to compare forecasts for the U.S. stock market to the return of the S&P 500 Index over the future interval(s) most relevant to the forecast horizon. The authors evaluated every stock market forecast against the S&P 500 Index’s actual return over four time periods—typically one month, three months, six months and 12 months.

They then determined the correctness of the forecast (i.e., whether the forecaster has made a true or false forecast) in accordance with the time frame for which the forecast was made. Because of the more random nature of short-term returns, they weighted the forecasts as follows:

 

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