Before the season started, English Premier League football club Leicester City were 5,000-to-one longshots to win the title. In fact, they were the odds-on favorite to finish at the bottom of the table and therefore dropped to a lower division. The team was largely made up of low cost acquisitions of has beens, never weres and maybe will bes. Their primary aspiration had been merely to avoid relegation.
Leicester’s ownership was ridiculed for hiring the 64-year-old Claudio Ranieri as manager last July. Despite having managed some of Europe’s top clubs, he had never won a championship and he had been out of work since the previous year when he was fired by the Greek national team after an improbable loss to the Faroe Islands. His only job in the Premier League had ended 11 years earlier.
But deft management, team spirit, a tremendous work ethic, surprising player development, nearly every transaction working out, nearly every player having his best year ever and a remarkable lack of injury combined to create what is likely the greatest longshot victory in the history of sport. The alleged “experts” — who picked the usual suspects to win it all — failed.
History has provided a long list of similar forecasting failures. Analyst Clifford Stoll argued that “no online database will replace your daily newspaper.” Bob Metcalfe, an electrical engineer widely credited with the invention of Ethernet technology, predicted that the internet would “in 1996 catastrophically collapse.” Federal Communications Commission commissioner T.A.M. Craven stated in 1961 that “There is practically no chance communications space satellites will be used to provide better telephone, telegraph, television or radio service inside the United States.”
Marconi predicted that the “wireless era” would make war ridiculous and impossible. Decca Records rejected the Beatles because they didn’t like the group’s sound and thought guitar music was on the way out. Every other studio in Hollywood but one turned down “Raiders of the Lost Ark” before Paramount agreed to make it and it became one of the highest-grossing films of all time.
Thomas Bell, president of the Linnean Society of London, summing up the year 1858 (which included the announcement of Charles Darwin’s theory of evolution by natural selection), stated: “The year which has passed has not, indeed, been marked by any of those striking discoveries which at once revolutionize, so to speak, the department of science on which they bear.”
In April 1900, the great physicist Lord Kelvin proclaimed that our understanding of the cosmos was complete except for two “clouds” — minor details still to be worked out. Those clouds had to do with radiation emissions and with the speed of light, and they pointed the way to two major revolutions in physics still to come: quantum mechanics and the theory of relativity.
At the World Economic Forum in 2004, Bill Gates predicted that, “Two years from now, [email] spam will be solved.” And nearly every political pundit gave Donald Trump no chance to win the Republican presidential nomination.
Most of the alleged experts making market predictions are highly educated, vastly experienced, and examine the vagaries of the markets pretty much all day, every day, Yet they too are wrong a lot — pretty much all the time in fact. Why are we so bad at forecasting?
The great Russian novelist Leo Tolstoy gets to the heart of the matter when he asks, in the opening paragraphs of Book Nine of “War and Peace”: “When an apple has ripened and falls, why does it fall? Because of its attraction to the earth, because its stalk withers, because it is dried by the sun, because it grows heavier, because the wind shakes it, or because the boy standing below wants to eat it?” With almost no additional effort, today’s scientists could expand this list extensively.
As Daniel Kahneman and Amos Tversky so powerfully pointed out, we evolved to make quick and intuitive decisions for the here and now ahead of careful and considered decisions for the longer term. We intuitively emphasize (per anthropologist John Tooby) “the element in the nexus that we [can] manipulate to bring about a favored outcome.” Thus, “the reality of causal nexus is cognitively ignored in favor of the cartoon of single causes.” In short, whenever we try to figure out complex future outcomes we enter dangerous territory with disaster lurking everywhere.
Even when we recognize the fallacy of thinking in terms of single, linear causes (Fed policy, market valuations, etc.), the markets are still too complex and too adaptive to be readily predicted. There are simply too many variables to predict market behavior with any degree of detail, consistency or competence. Unless you’re Seth Klarman or somebody like him (none of whom is accepting capital from the likes of us), your crystal ball almost certainly does not work any better than anyone else’s.
All that said, the idea that we can live our investing lives forecast-free is as erroneous as the market predictions that are so easy to mock. As Cullen Roche repeatedly emphasizes, “any decision about the future involves an implicit forecast about future outcomes.” As Philip Tetlock wrote in his wonderful book, “Superforecasting: The Art and Science of Prediction”: “We are all forecasters. When we think about changing jobs, getting married, buying a home, making an investment, launching a product, or retiring, we decide based on how we expect the future to unfold.”