The Motley Fool

Economic predictions are often wrong, but you’re not using them correctly either

Evolution has resulted in us having a deep-seated hatred of uncertainty. The future is inherently unknowable and that drives many of us crazy, inducing anxiety in all areas of life, not least in investments.

Most of us would agree it’s impossible to predict the future. When was the last time you turned to the local soothsayer and her crystal ball to forecast the oil price, or tried to predict Unilever’s full-year earnings in your tea-cup?

I’d guess (or hope) you’d answer never, yet investors have been known to seek out even weirder sources for investment advice, such as financial horoscope predictions. Yes, that’s a thing.

Fear of the unknown has driven many a sane individual to these odd ‘solutions’ but is it any less crazy to pin our hopes on an economic forecast?

The short answer is yes, it’s far less crazy. The long answer… well, that depends on how you use these predictions.

The butterfly effect

Each year our world grows ever-more connected. Governments lend more and more to each other, products are more and more frequently traded across borders and technology advances sweep multiple nations at once.

Many seemingly small developments can have a domino effect, impacting the economy, which in turn might influence government policy, leading to complicated consequences that can be impossible to foresee.

Some would argue that economists, those few brave enough to tackle the maddening reality we live in and who attempt to wrestle it into some form of rationality, are no better than mystics.

While I don’t bet on predictions, I strongly disagree. Forecasting is incredibly difficult, but it’s a necessary evil. Economists use a scientific approach to calculate potential futures.

Sure, you could argue the profession’s hit rate must improve. You could argue the efficient market hypothesis (EMH) should be dropped (it really, really should). You could argue that Homo Economicus, a foundational principle in some economic models that presumes humans are rational agents, should also go the way of the dodo.

But economists aren’t the only ones who could do with a fresh approach. A lot of investors also need to change how they use forecasts.

Potential futures, not betting tips

Firstly, we must acknowledge there are hundreds of potential futures, although only one can come to pass.

This realisation has only one logical conclusion: we must stop viewing economist forecasts as a tip on which to bet the farm. Instead, we should use these informed opinions to consider how our portfolios might fare in a variety of potential futures.

Indeed, the much-maligned economist might raise possibilities we had never even considered before, helping us avoid potentially disastrous investments.

In sum, I recommend widely reading reports if you have the time, before building a bottom-up, quality portfolio that will likely perform come rain or shine. Economist forecasts might not be the Holy Grail of investing, but to stumble into the future blindly is incredibly risky.

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