Propheteers: The Future of Wall Street’s False Prophets

Along with legitimate scholars and creative geniuses, the art and science of forecasting has always attracted opportunists eager to exploit people’s anxieties about the inherently uncertain future.  On Wall Street, propheteers today enjoy a fantastically favorable climate for their craft.

First, heightened uncertainty is fueling demand for confident predictions that create illusions of order and control.  We live and work in a global economy shaken by cycles of boom and bust, wars and simmering geopolitical conflicts, paradigm shifts in science and culture, not to mention trust-crushing “Black Swan” events such as 9/11, the housing crisis, and the fall of Lehman Brothers.  The less certain we feel about the world, the more comfort we find in the confidence of any “expert” who claims to know what happens next.

Second, propheteers today appeal to an uncritical and complacent public.  In civilized societies, we no longer sentence false prophets to death, as commanded in Deuteronomy.  The modern world embraces more forgiving distinctions between truth and falsehood, and it shortens our attention span so much that we rarely even remember which past predictions proved right or wrong.

Emboldened by the indiscriminate appetite for predictions, Wall Street propheteers don’t need to worry much about accuracy, and they rush to the media every day to tell the rest of us where we will make or lose money next quarter or next year.  With confident eloquence, these modern-day oracles claim to foresee everything that matters: corporate profits and revenues, growth rates for specific industries and the global GDP, changes in the unemployment rate and the fluctuations of the Fed chairman’s mood.

Behind the veneer of prophetic poise, the charade of forward-looking punditry on Wall Street amounts to little more than a specialized genre of infotainment.  The genre exists largely because of the symbiosis between the financial talking heads who want media coverage and news outlets that need to fill airtime and column inches.  Nothing wrong with enjoying the resulting spectacle, just as there’s nothing wrong with watching a late-night infomercial that promises to bring us great wealth or slimmer waistlines.  But it’s important not to mistake superficially informative entertainment for sound advice.

As Daniel Kahneman’s latest book Thinking Fast and Slow reminded us, experts perform poorly at predicting the future, and experts in finance and economics deliver especially disappointing results.  Mathematician David Orrell’s The Future of Everything: The Science of Prediction reaches similar conclusions.  Further evidence for Kahneman’s and Orrell’s thesis mounts every day, as financial analysts and economists continue to forecast the future with about the same precision as psychics and card readers.

For example, consider the Citigroup Economic Surprise Index (CESIUSD).  Positive values in this widely followed benchmark suggest that economic indicators exceed forecasts, and negative values, of course, track the underperformance of actual indicators relative to forecasts.   The index recently turned negative, prompting the latest round of speculation about a market correction.  But the main message of this chart is that economic forecasters vacillate between excessive optimism and excessive pessimism, seldom delivering accurate predictions.

Similarly, we’ve long known that Wall Street analysts can’t reliably predict corporate earnings.  In fact, most of them don’t even try.  Wall Street earnings estimates primarily reflect the “guidance”  analysts receive from investor relations departments and CFOs.  I wrote about the theatrics of “expectation management” in 2001.  This essay got a response from SEC chairman Arthur Levitt who tried his best, for better or worse, to combat this practice.  But little has changed since then: companies continue to “guide” estimates lower to manufacture the illusion of outperformance.  So far this year, analysts underestimated U.S. corporate earnings at a rate of 79 percent, and they misjudged the key qualitative trends for 2011.  None of this helps restore the tattered credibility of Wall Street analysts.

However, past mistakes have not diminished the fervor of false prophets.  Since 9/11, we’ve heard many doomsday scenarios for financial markets and the global economy.  Increasingly, over the past four months, we are also hearing optimistic projections.

  • Finance professor Jeremy Siegel recently grabbed headlines by predicting on CNBC that Dow Jones would hit 15,000 or possibly even 17,000 next year.  Last week, he defended these predictions, again citing the strength of earnings growth among U.S. companies.
  • Barry Ritholtz, a veteran financial blogger and commentator, delivered another cheery prognosis last week and again yesterday based on the unassailable thesis that America and its financial markets will be just fine because America is so innovative.
  • On the other hand, economist Andrew Smithers estimated in March that U.S. stocks are overvalued by at least 50 percent.
  • On a broader scale, optimistic forecasts seem to be gaining momentum. In the latest Barron’s survey of professional money managers, 55 percent of the respondents described themselves as bullish, up from 52 percent in the prior survey. On average, the bulls expect the Dow to reach 14,183 by June 2013.

Whether they guess right or wrong, propheteers can entertain us.  Sometimes, they can even educate us.  But they will not make us rich.  Sadly, this failure alone will not take them out of business.  As long as we continue to take them seriously — as long as the media continue to let their failures escape critical scrutiny — the only thing we can predict confidently is that propheteers will enjoy a bright and prosperous future.

3 thoughts on “Propheteers: The Future of Wall Street’s False Prophets

  1. You may have misunderstood the point of my column: It was a pushback against the relentlessly negative, backwards looking commentary circulating today.

    We are in complete agreement about the Folly of Forecasting (See this 2005 column

    However, there has been a rise of doomsayers that have gotten to be annoying in their relentless, negative, wrongheadness.
    I am hardly a cheerleader, and have been criticized for being too negative. But at a certain point, the end-of-worlders need someone to say the world — and the US are not coming to an end.

    That is what this column was about

  2. Fair point, Barry. Indeed, we are in agreement about the central point, and I loved your piece. I certainly would not want to mischaracterize your work; in fact, I deeply empathize with the urge to push back against popular delusions.

  3. Reblogged this on Lev Janashvili and commented:
    I hereby predict that, in 2015, we will see more propheteers humbled more dramatically by realities that defy their theories more incomprehensibly than ever before.

    Instead of the familiar vocabulary of forecasts and predictive models, we’ll do better if we cultivate our epistemic humility, a renewed comfort with irreducible uncertainty.

    Beware the advice of financial analysts accumstomed to viewing the world through the reductive matrix of Excel spreadsheets with GAAP data.

    Don’t obssess about the reliability of any predictions. Focus instead on the validity of the “metrics” being predicted. Examine the literature on the dubious meaning or relevance of the economic vital signs that dominate news headlines — the unemployment rate, GDP growth, the performance of market indices, or corporate earnings that miss, meet or beat Wall Street estimates, etc.

    These metrics are not completely divorced from underlying realities. But in aggregate, they form a misleading narrative, a dense layer of noise that drowns out the ticking of time bombs.

    This is not just an apocalyptic proclamation. It’s also a testable hypothesis. If we simply ignore the noise of allowable opinion, we’ll see that the digital displays on the “time bombs” convey simple messages and inescapable questions typically absent in mainstream punditry. To start:

    — How long can quantitative easing (QE) continue?

    — How much longer will investors maintain their trust in the integrity of the global financial system as it becomes increasingly evident that the system relies on accounting standards that materially distort the value of underlying assets?

    — How much longer can the system sustain rising economic inequality while suppressing sparks of revolt?

    — How much longer can the current political duopoly maintain the tyranny of no alternatives.

    I hope to delve into these questions in my posts here over the next few weeks.

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