Fortune telling is reliable to some extent

Expert predictions: brave, confident and mostly wrong

Every year again: At the turn of the year there is a multitude of expert predictions in the media about what the future will bring. Forecasts about future developments in the financial markets are particularly popular. Although most experts are very knowledgeable in their areas of expertise, this regularly does not mean that they can reliably predict future events. In his guest article for the VAA newsletter, Joerg Lamberty from FVP Gesellschaft für Finanz und Vermögensplanung shows that the degree of investor acceptance of financial market forecasts tends to have an impact on your investment strategy.

Neurologist and investment strategist William J. Bernstein has observed that there are three types of financial professional: First, those who do not know that they cannot predict future market developments. Second, those who know. And third, those who know but whose job depends on pretending they can. Most investors are aware that no one can reliably predict the future. That is why they do not believe in crystal balls and fortune telling. Nevertheless, the stock market forecasts that were particularly popular at the beginning of the year are attracting your attention again. This is understandable because accurate predictions of an abrupt change in the financial markets can be very valuable. In addition, in the past there have always been one or the other expert who was correct with his forecast and was able to make high profits. However, the lack of accuracy of these experts in their later predictions suggests that the previous hit is more a matter of luck than ability.

Reliance on forecasts influences investment strategy

According to the successful fund manager and author Howard Marks, the question of whether an investor believes that financial market forecasts have a certain degree of probability and are therefore useful has a significant influence on the investment strategy they pursue. Investors who believe in financial market forecasts tend to be more willing to bet on rising share prices (long only) and to hold a concentrated portfolio of a small number of individual shares or funds. They prefer to invest in technology and growth stocks rather than defensive stocks or funds. On the other hand, investors who do not believe in a high hit rate for forecasts about the future development of the financial markets tend to prefer broad diversification across several asset classes, currencies and regions and avoid cluster risks. In addition, they take into account hedging strategies (long short / market-neutral) and consider a favorable valuation to be more important than potential future growth when selecting stocks or funds.

The first strategy tended to produce better results in the years between the uptrend and the market corrections in 1961, 1973, 1987, 2000 and 2007. The longer the upward phases lasted, the stronger the confidence in the sales-motivated financial market forecasts of the financial industry grew. In contrast, with the second strategy, investors were better prepared when there was a sudden change in trend and a crash. After the stock market crash, they had lower losses and therefore more capital available in order to benefit in the long term from purchases at the then low prices.

Questioning the influence of forecasts

At the beginning of the year - in other words, the "high season of financial market forecasts" - we as investors should once again ask exactly what influence our own or third-party forecasts about future developments in the financial markets will have on our investment strategy. On the one hand, a defensive strategy does not make sense if we assume that a certain forecast about the development of the financial markets will occur with a high degree of probability. In this case, hedging strategies and broad diversification would be unnecessary. But if we assume that we don't know what the future will bring, it would be negligent to pretend we do with an appropriate investment strategy. As a cautionary example, the upward phase from 2004 to 2007 before the last major crash should be recalled, when many investors overestimated the predictability and controllability of events and underestimated the existing risks.