By Salman Ahmed
At this time of year my inbox becomes inundated with reports full of predictions for the coming year. Some contain broad themes to watch for, while many provide precise market return expectations.
In general, the exact forecasts seem to come from economists and strategists using highly complicated math. One firm was confident enough in their model to put out their market return predictions over the next 20 years down to two decimal places no less.
Surely these intelligent people don’t think their models are that good? Especially for something as fluid and volatile as the financial markets. Unfortunately, an elegant model can fool us into believing they can be precise, even when there is no precision to be had.
Harry Markowitz, a legend in the investment world, put it well in 2009. He was wary of the confidence people place in their formulas, even though he won a Nobel Prize in economics for his own complex financial model.
“All financial models are an attempt to describe an infinitely complex reality. As a result, to achieve any success at all, portfolio theorists must make certain simplifying assumptions … It is precisely at the point where the assumptions break down that financial models, pushed to their limits, lead to disastrous consequences.”
At Steadyhand, we browse through the reports for tidbits of information and different perspectives, but we don’t pay too much attention. We are sceptical of the pseudo-precision in most of them. It’s part of what I like to call the financial smoke machine. A smoke machine does a good job of diverting your attention from all the defects in a dingy pub. But when the smoke clears, it’s still a dingy pub (nothing against dingy pubs here). The convoluted math is aimed at distracting you from what the numbers actually are: guesstimates. Nothing more.