The Game of Financial Market Predictions

By September 26, 2019Finance, Psychology
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As humans have evolved, the ability to predict events days, months or years into the future has never been relevant to survival. Rather, our DNA has been equipped with the fight or flight response. It is our quick ability to react to the event once it has happened that keeps us safe. 

Speaking on a panel at the 2018 NeuroLeadership Summit, social cognitive neuroscientist Kevin Ochsner said, “Our brains evolved to manage the needs of the now and of the not-too-distant future—your immediate environment, and short-term goals for food, water, shelter, and child-rearing.”

Although the world has evolved, humans still carry the same neural architecture as our early ancestors, which means that our brains are still inept at predicting future events. The closest we get is our ability at using sensory data to foresee events in the immediate future, as in microseconds. This enables us to predict the trajectory of a fast-moving baseball which enables us to catch it. 

In his fascinating documentary series, “The Brain”, Stanford Neuroscientist Dr. David Eagleman explains how in practice predictability is impossible. He demonstrates this by dropping a single ping pong ball into a container of one hundred and fifty ping pong balls. It is possible to correctly identify where the ball will land but as it sets off a chain reaction of movement with the other balls the situation becomes more complex. He states, “Any error in the initial prediction, no matter how small, becomes magnified as balls collide and bounce off the sides and trigger other balls. Soon it becomes completely impossible to make any kind of prediction about how the balls will end up. The balls have no choice in the direction they move. They have no freedom to do it differently, and yet the system is completely impossible to predict.”

A human’s thoughts, feelings and decisions emerge from the innumerable interactions in the brain. In comparison to the activity of one hundred and fifty ping pong balls, the brain has billions of times more interaction every second and never stops during a lifetime. In addition, each individual’s brain is embedded in a world of other people’s brains. Dr. Eagleman goes on to say, “the neurons of every human on the planet fire, interact and influence each other creating a system of unimaginable complexity. This means that even though brains follow predictable rules, in practice, it will always be impossible to know exactly where any of us are going.”

Nassim Taleb developed a line of argument throughout his previous books, Fooled by Randomness, The Black Swan and Antifragile,  that the defining characteristic of future change is that it is impossible, and pointless, to try to predict it. Instead,  he argues, it is essential to make peace with uncertainty, randomness and volatility. Those who do not — who insist not only on trying to predict the future, but also on somehow trying to manage it — he disparagingly calls “fragilistas.”  

So if predictions are impossible, what makes such a large number of financial professionals believe they have the ability to identify, as in Dr. Eagleman’s demonstration, the correct outcome of the millions of interactions that are set off from the chain reaction of one event? 

The human brain values certainty in a very similar manner to how it values food, sex, and social connection. Certainty offers a perceived control over the environment that is in itself inherently rewarding, the brain treats uncertainty, and the inability to predict the future, as a source of deep discomfort.

This is essentially why viewers continue to tune into their favorite financial tv personalities, in the hopes that they will describe the future and give them a greater sense of certainty. The main certainty on behalf of the financial tv personalities is that regardless of their faulty predictions, they are protected by a number of disclaimers at the end of the show that viewers tend to disregard.

The Financial Times looked at the number of countries that the IMF expected to be in recession for every year since 1991 and compared it with the number of economies that turned out to have actually contracted. Over the last 27 years, the IMF predicted every October that an average of five economies will contract the following year. In practice, an average of 26 have contracted. The difficulty in getting forecasts right is not unique to the IMF. “All macroeconomic forecasters are poor at predicting downturns,” David Turner, head of the economics department at the OECD told the Financial Times.

The past is littered with a multitude of failed predictions over the years made by economists, financial analysts, TV financial personalities, or the Federal Reserve. 

Who can forget on March 11, 2008, Mad Money host Jim Cramer told a viewer who wrote into his show, “Bear Stearns was fine!” right before the stock absolutely collapsed. The stock was trading at $62 per share. Just 5 days later, the firm was picked up by JPMorgan Chase for $2 per share. Yet, Jim Cramer is still on CNBC shelling out predictions daily to a mass of viewers eager for some kind of certainty.  

In the past, there have been correct predictions. Although with no real timing accuracy, they can be considered a lucky guess, since none have been able to replicate the predictions that made them famous.

Elaine Garzarelli became a start with her prediction of the 1987 crash. Since then, her record was mixed. For instance, on July 23, 1996, she told clients that US stocks could fall 15% to 20% from peaks reached earlier that summer. The Dow Jones industrial average closed that day at 5,346.55, and had risen 45% by Nov 1997.

Elaine Garzarelli

Meredith Whitney catapulted to fame after her prescient October 2007 report on Citigroup Inc. and put this previously unknown analyst on the cover of Fortune magazine. Following shortly after her ascent to prediction stardom, she predicted an “as yet unrealised” meltdown in municipal bonds in a 2010 interview on “60 Minutes.” A short-lived hedge fund followed, but the fund lost money and closed in 2015 amid a legal dispute with its anchor investor.

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Meredith Whitney

Paul Tudor Jones also called the 1987 crash, yet last year predicted that the US 10-year Treasury yield would rise to a “conservative” 3.75 percent by the end of 2018. The result? It closed the year at 2.43 percent and has since dropped to 1.73 percent. However, the ability to make predictions should not be confused with one’s ability to react and trade off of events. It is the trading ability of PTJ, his ability to react to situations, and trade accordingly that has made him wealthy.

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Paul Tudor Jones 1987

Bob Johansen, author of Leaders Make the Future: Ten New Leadership Skills for an Uncertain World, states that the first step is to strive not for certainty, but for clarity. Given that the future is inherently unpredictable, we can never be certain about what the future will bring. 

If we really had the ability to forecast future events, there would be no such thing as an unforeseen crisis!