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.