Market Forecasts: We Go Wrong in Predicting Even the Impact of Events, Not Just the Events
I remember listening to a big shot, at one of India’s largest corporate houses, about India’s economic prospects in 2008; this was at the fag-end of December 2007. With a ringside view of economic trends, the flow of funds and business sentiment, he was extremely positive about 2008, knowing that billions of dollars were about to flow into infrastructure, real estate and other businesses. 
 
India will not be able to absorb the torrent of money that is headed our way, he said, especially from the Gulf countries, since oil prices had been high and petro-dollars were looking for an investment destination. India was then seen as one of the most attractive investment destinations on earth. This corporate honcho was honestly sharing what he was witnessing from very close quarters. 
 
We know what happened next. 
 
By the third week of January, a global market decline was underway; but it was just the trailer. Throughout 2008, one crisis after another hit the US and morphed into what is known as a global financial crisis (GFC) that affected all markets and economies around the world. A couple of countries were literally bankrupt. 
 
Indian indices were down almost 60% for the year, recording one of the biggest crashes in living memory. The episode assumes significance because it is that time of the year when investment strategists, fund managers and sundry opinion-makers pull out their crystal balls and gaze into them to let us know of their forecast for the next year. 
 
My real-life anecdote and innumerable others forecasts like that one prove that this yearly ritual is a farce. Every year, major Wall Street institutions put out a year-end target for the S&P500 index. 
 
Last year, Wells Fargo set a target of 5,200, Goldman Sachs 5,100 and JP Morgan 5,050 (yes, they herd together even while forecasting). The index closed the year at 3,839. 
 
The apologists will ask: Who would have thought that Russia would invade Ukraine? 
 
That is precisely the point. The crystal ball can never anticipate all the big events that move the market and impact economies and countries. And yet, we have an insatiable desire to lap up forecasts. 
 
We Can’t Predict the Effect Either
 
The outcome of such forecasts is far worse than a toss of a coin. This is not merely because of unknown causes or unanticipated global factors such as the invasion of Ukraine which happened just a few weeks after Wall Street had made its grand annual forecasts. 
 
But what really makes a mess of forecasts is a second reason—the effect or impact of such unanticipated events. The fact is, even if we can anticipate such major happenings, we can still be wrong in predicting their effect or outcome. This is difficult to understand because it is counter-intuitive.
 
Take the case of what happened in 2022. Imagine someone asking a market expert to predict the effect of the following on the Indian stock market: Russia invades Ukraine, oil prices shoot up, the US kicks Russia out of the global settlement system and freezes the assets of Russian billionaires; Russia stops supplying gas to Europe; US inflation hits a record 8% causing the Federal Reserve to hike interest rates from 0.25% to 4.25% in nine months and China bumbles badly in controlling rapidly rising cases of COVID-19 in the country.
 
Rising inflation and escalating interest rates, together, act as a cold wet blanket and slow down growth worldwide. Also, the conventional wisdom is that when the US sneezes emerging markets such as India will catch a cold. 
 
Logically, in this set of circumstances, everyone would have predicted a market crash like 2008. And yet, the Indian stock market went up last year. 
 
What about 2020? If anyone had told you that, in March 2020, a pandemic would suddenly bring the whole world to a standstill, leading to severe global lock-downs, high unemployment, business closures, a migrant labour crisis, a complete shutdown in travel and entertainment businesses, what would you have predicted for the year? 
 
Your forecast would have been an uncontrolled rise in bad debts, severe contraction in profits and a huge market crash. 
 
It did not happen. 
 
Not only did nobody anticipate the cause (or calamity), but once the cause was known, no one could anticipate the effect. 
 
Here is another piece of evidence that we cannot predict the effects, even if we know the cause. A study by David Cutler, James Poterba and Lawrence Summers in March 1988, titled "What Moves Stock Prices", concluded that even if investors knew tomorrow's news today, it would not be very useful. This is because big moves have happened on 'no news' days and many times no move happened on 'news days'. 
 
Why are even experts so bad at predicting effects, not just causes? Because economies and markets are not static systems following physical rules; academics describe them as complex, emerging, adaptive systems. The impact of any major external event causes millions of people to react and interact in a chain-like process known as a feedback loop. The effects of such continuous interaction with everchanging external factors are obviously impossible for the human mind to grasp and predict. 
 
So, the next time, you come across an apology for a wrong forecast like “who would have predicted…”, remember that even if we had predicted the cause, the forecast for the effect would have probably been wrong.
 
(This article first appeared in Business Standard newspaper)
Comments
gsreenat
1 week ago
Yes accountability is a big issue and virtually non existent for the so called experts and analysts and media houses. They get away by saying that predicting the market moves in the very near term is impossible and stick to so called mid to long term prospects. Further in most cases there is no clear definition of the mid and long term time periods.
adityag
2 weeks ago
John Mearsheimer was right all along.
but allegation of insider trading after so many ye
3 weeks ago
it is extremely difficult to understand why indian market is so far immune for external shock because though we are subsidized by russia in spite of that we have to pay hefty for our import bill our export will be dented we are not renowned for corporate governance our hdi is extremely low, debt is increasing,fiscal deficit is poor.foreign remittance will be influenced even warren buffet will be puzzled leave aside ordinary investor like us but my opinion 2026 woule be clear
yerramr
4 weeks ago
Uncertainties always override risks making any prediction, a gamble. Your point of veiw is very practical.
Jagadesh
4 weeks ago
Very insightful and practical assessment.
indiafocus
4 weeks ago
Very honest and insightful anaylsis, congrats Debhashis ! Even the most rigorous "analysis" is fraught with huge unknowns, blanks and question marks. Its called "life on earth". Its time we all were more honest and more humble about fancy terminologies and sly marketing, all of it disguised as tradecraft.
pmbhate
4 weeks ago
While the experts get it wrong most of the time they continue giving themselves handsome bonuses and drive around in Audis, BMWs and Mercs.
suketu
4 weeks ago
Wealth management companies always want you to buy ,never to sell so they always paint a rosy picture that markets are always going up.They distort the truth also to gullible investors.Best to avoid them .
parthi1961
Replied to suketu comment 4 weeks ago
Very True. Some one had predicted that Crude will touch $200 per barrel in 2006. What happened is plummeted below $50 per barrel.
suketu
Replied to parthi1961 comment 3 weeks ago
Vijay kedia said "ignore the noise".Bull market or bear market the companies who are fundamentally solid wl grow over 10-15 yrs like Page,MRF,etc and become multibaggers.
narayansa
4 weeks ago
I wanted to put an emoji, messed it up. Excellent article!
narayansa
4 weeks ago
????
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