Sell Stocks Now and the forecastor's paradox

January 15, 2016 04:00 PM

It’s easy to be cynical about financial forecasting and question the motives and conflicts of market forecasters. While some wish to create controversy and buzz to attract attention to themselves or their product or services, others are reluctant forecasters—attempting to balance the insatiable appetite of traders and investors always hungry for forecasts, while trying their best to put forth a conservative, high probability, do-no-reputational-harm forecast. 

The bottom line is that with the exception of stock promoters and other market bottom feeders, very few forecasters have anything to gain by being wrong. Fact is, the majority of financial market forecasters not only want to be accurate, but studies tell us that they are pretty certain that they will be.

In 2010, Warsaw researchers Tadeusz Tyszka and Piotr Zielonka published Expert Judgments: Financial Analysts vs. Weather Forecasters. The study asked two groups of experts—financial analysts and weather forecasters, to predict corresponding events: The value of the Stock Exchange Index and the average temperature of the next month. Tyszka and Zielonka found that “though both groups of experts revealed the overconfidence effect, this effect was significantly higher among financial analysts than among the weather forecasters.”

The study concluded that weather forecasters have an “awareness of uncertainty” about the natural world that “causes these experts to manifest a lower overconfidence effect than experts from the other domains; (while) paradoxically financial analysts, having less precise knowledge than the weather forecasters about the underlying system, can be more self-assured.” (Perhaps that explains what Kevin Davey was getting at in ”Beware the cult of personality” (page 46).

The research identifies a forecaster’s paradox—those with less precise knowledge tend to be more certain. That cannot be very reassuring to traders and investors.

Which brings me to the subject of our second issue of Modern Trader and its cover story, SELL STOCKS NOW—10 Reasons to Reduce Equity Exposure (August 2015). Our editorial team wrestled with this cover story, internally debating the potential for perceived hypocrisy by our readers coming on the heels of declaring much of the financial media guilty of providing care and feeding to those perpetually false prophets. 

Moreover, we were aware that historically, “market call” covers on national investment-focused print publications have not fared well. Businessweek’s ominous Death of Equities cover published in August of 1979, right before a multi-generational bull market, immediately came to mind. The publication lost immeasurable credibility for that infamously inaccurate cover. To my prior point—very few forecasters have anything to gain by being wrong.

Despite the timing, accuracy and business risks, we came to the conclusion that the arguments in favor of a market decline that we had curated and conceived were too compelling to ignore. We were not really forecasting, rather making a market call based on a wealth of data. It is worth noting that our intent is not to bash forecasters, rather to make better forecasts and hold forecasters accountable. Forecasts are how we make important decisions (see It’s Not Just What You Forecast, page 16).

So, we went to print with SELL STOCKS NOW as a cover story on June 17 with the Dow Jones Industrial Average, S&P 500 and Nasdaq at 17,936, 2100 and 5064, respectively. Within a matter of weeks of the issue reaching subscribers and newsstands, U.S. stock markets collapsed, with each major index trading at least 10% lower, in “correction” territory. Our market call was promptly validated and the second issue of Modern Trader received its second consecutive award for editorial excellence in the business and finance category for our prescient and timely cover story.

Whether a forecast or a market call, we are not aware of any national or pedigreed financial periodical that made such an assertive (let alone, accurate) market prediction, alerting its readers of a likely imminent broad market equity decline. Subsequently, the markets did promptly recover from correction territory but have since failed to make new highs. 

In light of the Fed’s new course, those 10 Reasons to Reduce Equity Exposure remain timely and relevant to traders and investors—at least I feel pretty certain.

About the Author

Jeff Joseph is the CEO of The Alpha Pages, the parent company of Modern Trader magazine.
E-mail him at jj@alphapages.com or find him on Twitter @alphapagesceo and @venturepopulist.