With the approach of the upcoming elections, we've entered what I refer to as the "silly season." The financial media is filled with recommendations as to what you should be doing with your portfolio. You'll hear recommendations to increase or decrease your allocations to certain industries (such as defense contractors or health care providers) depending on the outcome of the elections.
If such recommendations had any value, we would see that in the results of actively managed funds. Yet, there is no evidence of persistent ability to outperform appropriate risk-adjusted benchmarks beyond the randomly expected.
Despite this knowledge, I continue to get bombarded with questions about the impact of the elections on portfolios. It's as if investors didn't already have enough to worry about with the financial media and Wall Street reminding them daily about such issues as the budget deficit, the fiscal cliff, higher tax rates, higher inflation, the Eurozone crisis and Iran.
Such concerns cause investors to think about whether their plan is flawed. And I find that when it comes to the election, those with strong leanings (either liberal or conservative) tend to worry that results for the market and the economy will be dire if their candidate loses.
Unfortunately, all the negativity fueled by the 24-hour news cycle we live in causes investors to question even well-developed plans, leading to action when, as Warren Buffett stated: "Inactivity strikes us as intelligent behavior." I'd add the caveat that inactivity is intelligent behavior for those who have well-developed plans. (Those without them should begin writing one.)
One reason you should ignore forecasts is that if you have a legitimate concern about an issue (the risks are real), you can be sure that the institutional investors that dominate trading, and therefore set prices, are also aware. Since the risks are known, it must be that the information is already built into current prices, and you can only benefit from the information if you can interpret the information better than the market. Yet, there is no evidence of the persistent ability to do that.
The other reason you should ignore forecasts, especially ones portraying doom and gloom, is that the evidence demonstrates that there are no good forecasters. Philip Tetlock conducted a 20-year study in which experts were asked to predict the future. He concluded that it made no difference whether forecasters were Ph.D.s, economists, political scientists, journalists or historians, whether they had policy experience or access to classified information, or whether they had many years of experience in their chosen line of work. The only predictor of accuracy was fame. The most famous - those more likely feted by the media - made the worst forecasts. Importantly, he also found that optimists tended to be more accurate than pessimists.
Tetlock warned that no matter how unequivocal the evidence that experts can't out-predict chimps, we should expect business as usual: Pundits will continue to warn us on talk shows and op-ed pages of what will happen unless we follow their predictions. We, the consumers of expert pronouncements, latch on to experts because we need to believe in a controllable world and have a flawed understanding of the laws of chance. In other words, we want certainty, even when we know logically that it doesn't exist. With investing, it is a desire to believe that there's someone who can protect us from bear markets and the devastating losses that can result. That leads to the "Wizard of Oz" effect. We come under the spell of wizards, authoritative voices who we are trained to take their words as truths. We want to believe that we can control things, because as the Woody Allen film Match Point put it, "People are afraid to face how great a part of life is dependent on luck. It's scary to think so much is out of one's control."
One of my favorite sayings is that there are three types of investment forecasters:
Those who don't know where the market is going
Those who don't know they don't know
Those who know they don't know but get paid a lot of money to pretend they do
In other words, they are playing an entirely different game. Tetlock relayed what a think tank member once told him: "I fight to preserve my reputation in a cutthroat adversarial culture. I woo dumb-ass reporters who want glib sound bites. Tetlock added that "In his world, only the overconfident survive, and only the truly arrogant thrive."