The Problem with Trying to Predict the Future: Whooz t’ Know?

Friday, January 27, 2006 at 11am
By John Friedman

Today I awake to a report that growth of the GDP last quarter was anemic, at a 1.1% annual rate (3% to 5% is usually considered Goldilocksian just right, in the sense that too much growth can generate wicked inflation, and too little growth can feed on itself to generate recession and even depression).

Now, as a young lad, I would have thought, Good, that means the market will have gone down. To some folks that seems like an odd thought, because to them the word good should not be combined with the phrase the market will have gone down. But I thought they were fine together, because even back then I appreciated that, so long as I wasn’t in the mode of selling out major chunks of my portfolio (which, after all, is something that awaits us in our later years of life, right?) that down was good because I was a net buyer, rather than a net seller, meaning that I was buying a whole lot more than I was selling, so lower prices were, all things being equal (that dread phrase), good.

I still feel that way about down markets. After all, most of the folks whose financial health I help look after are net buyers.

The difference between when I was a young lad and now, though, is that I no longer expect to be able to predict the direction of the market in response to economic reports. So today, no longer a young lad, I wake to the news of anemic GDP growth and say to myself, I wonder which way the market will move?

And, sure enough, the young lad takes a lesson from the . . . not-young-any-more-lad but not-ready-yet-to-call-it-old lad, to see that the market has gone up smartly (or dumbly, depending on your opinions of these things) from 10815 to 10932, i.e., something just shy of 11000 and more than 1% up.

So, today, the grand aggregator of personal opinion that is the market does not hear of this economic anemia and then think, Gee, we’re going into recession and corporate profits will be low and everything is going to be going to hell in a handbasket at least for a while.

No. Instead the grand aggregator chose, in this particular context — this particular set of circumstances, never to be repeated again and never having occurred before (oh you Red Queen you!) — to hear the news and say, Oh joy, that means that the interest rate increases the Fed has been putting through, taking us from short term rates of 1% or so up to 4.5% or so, will be ending even sooner than we thought, and that means that the cost of money and capital — the engine that drives business — will go down, and that is a good good thing for us, a good thing for the market.

* * *

 


Now, I’m no economist, and I remember well how, in the last economics class I had — the one with a bunch of really smart people — how I would often get the stochastics precisely backwards, as in thinking that a given cause on the market would have exactly the opposite effect that a good economics student would expect. And I remember that I could always see a way that either effect could make some sense, and how neither seemed totally out of whack or preferable to the other.

Now for the purposes of Macro with Rose, I was just plain wrong. I would get a bad grade.

But back then I would also think, Friedman’s Law of the Average is at work here, so if I am thinking that a movement in either direction is conceivable, then probably lots of people would think that was the case as well.

And so, no longer a young lad, I know that the market is a whole lot more like me as a confused Macro Econ student among a bunch of go-getter MBA-types, than it is like the tried-and-true, one-direction-is-right and one-direction-is-wrong Mankiwian wisdom to which one is exposed in Macro. (Greg Mankiw is the guy who wrote the text book for that class; he is also the fellow who got excoriated and then kicked out of the Bush administration for suggesting that out-sourcing was good, nicely timing that suggestion to the time when out-sourcing was a big political and media hot potato — in other words, he stepped right into it, and Karl and Andy were not pleased, so GW agreed that he should go) (please do not ask me how to say his name, or the modification of his name into a label for his school of thought; I do not know).

So, no longer a young lad, I know that I don’t know which way the market is going to go when faced with economic news, even when the economic news is unambiguously not great for putting food on our collective table (and food-on-the-table is, after all, the ultimate economic fact, isn’t it?), such as a GDP figure coming in well more than half below the expected figure (2.8% was the consensus going into the release).

* * *

So what does knowing-that-you-don’t-know mean for a person’s financial health? Two things.

First, for many people (me, anyway), coming to grips with one’s inability to predict markets and economies and stock prices and whatnot is one of the biggest knowledge-hurdles to jump over — for here the hurdle is to know that you don’t know and never will know — but, once jumped over, is a feat of enormous power, capable of producing a true freeing. Most of us are not comfortable admitting total abject defeat, and that’s what’s required here: you have to admit that there is no way, no how, you are ever going to be good at predicting price movements in the stock market.

T’ain’t no figgering; t’ain’t no knowing.

But once you jump over that hurdle, seriously wonderful financial health things happen. Most readily, people who’ve surrendered the edifice of able prediction do not expect to, over time, beat the market and are instead happy to match it.

Now if financial health has something to do with happiness (and I think it does, bigtime), then this can be key. Because expectations are one key to a person’s s happiness, aren’t they, in the sense that, when our expectations are met, we feel better and happier, and, when our expectations are left unfulfilled, we feel worse and less happy?

When folks expect to beat the market, then, they tend to make themselves feel crazy because they fail. They are less happy in their financial life — less happy in their financial skin — and are therefore less financially healthy.

Letting go of that expectation, on the other hand, makes a person feel better about his or her investing. Happiness and financial health ratchet up quantum-like, and that is predictable. Give up the expectation and you are quite likely to feel financially happier.

* * *

Second, getting to the exalted knowing-that-you-don’t-know plane of financial self-knowledge also makes your investing chore a whole lot easier — not even a chore, really — because matching the market is a piece of cake, and getting more so every day. All you have to do is slap yourself on the wrist every time you are tempted to get too cute about it. Just be simple. Just be tame.

And if you have the urge to set out for that lofty plane of better-than-market returns (alpha is the term the financial wonks use for that plane), wanting to try your hand at predicting that-which- is-mostly-unpredictable, then a good piece of advice is to quarantine that part of your portfolio — the trying-to-beat-the-market part — so that you can really, really, really, honestly and truly, gauge your performance.

Gauging performance is a lot harder than most people think. For instance, do you know how well your 401k has performed? Usually the only people who have any inkling of an answer to that question are those whose 401k is housed on a platform that provides that information (on statements or online) and not all that many platforms do that because it is bad for their business model (and the regulators sure haven’t required performance metrics in that context, unlike in the mutual fund prospectus context, in which they’ve at least made a start).

* * *

So when you wake up and here that the economy didn’t grow very much last quarter, and that it’s Chairman Greenspan’s last week at the Fed, what’ch’ya gonna think, what’ch’ya gonna say?

If you’re me in my 20s, you say, market’s gonna tank.

If you’re me in my . . . 40s . . . you say, whooz t’know?

So the truth can set you free — and here setting-you-free means making your investing a no-brainer because, as it turns out, brains ain’t going to do you much good here, no way, no how and, in fact, are more apt to do you harm than to help you along your merry financial health way.

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