In 1977, just prior to “The King’s” untimely passing, 170 people were earning a living as Elvis Presley impersonators worldwide. Twenty years later, their number had increased to 85,000 and experts were predicting that, by 2019, half the world’s population would be Elvis impersonators. See what happened there?
In spite of the fact that much of their output can be as ill-conceived as the foregoing (ridiculous, but genuine) example, the influence of “expert” predictions on investors’ behaviour is arguably as powerful as it has ever been. Though by no means the only cause, much of the short-term volatility seen in financial markets is the result of investors’ response to the release of economic data or company results that fall outside the range of consensus estimates. All of which flies in the face of common sense, since, to even the most casual observer the quality of much of these experts’ work is, at best, pretty ordinary.
The reasons for this are many-fold, but in a number of instances are behavioural factors, chief among which is the “herd mentality”: a fear of lifting one’s head above the parapet or, conversely, the comfort of being wrong in groups – the flip-side of that coin – means that forecasts can be slow to change, despite the existence of clear evidence to the contrary. “Anchoring” – a reluctance to depart too far from the previous data point, or even just sheer laziness / uselessness (I’ll just have a look at what my peers are doing) also prevail. Then, as with our example above, there’s the blind extrapolation of a trend to a clearly unreasonable conclusion, but, hey, that’s what the numbers say!
To complicate matters further, the methodology behind economic data is itself far from straightforward. Take, for example, US GDP figures. Due to the way in which the raw data is collected or submitted and the timescale over which this information is collated, there are actually three official GDP announcements: a preliminary estimate, a revised estimate and a final figure. Other data series are also routinely updated in the same way. As history shows, these numbers can change meaningfully (and not necessarily in the same direction), particularly when extraneous influences, such as abnormal weather, are involved – the Q1 figures in 2014 and 2015 being cases in point. At each stage of this process, however, there remains the likelihood of a knee-jerk reaction from investors when / if each of these releases does not match the majority forecast.
And then there’s China’s data! Although there is an almost universal acceptance that China’s GDP figures are (there’s no way to be kind here) completely made up, Mr Market is still prone to respond impulsively when the announcement of an imaginary number doesn’t meet analysts’ prediction of that imaginary number. Einstein’s (alleged) definition of madness – doing the same thing over and over again and expecting a different outcome – springs to mind.
Whatever the reasons (and there are many more), numerous academic studies have shown that the predictive record of economists, political forecasters and corporate analysts is, generally speaking, woeful (there are, of course, individual exceptions). And yet, time and time again, investors will be compelled to reach for the buy / sell button, fire up the trade blotter or send off that fax / e-mailed instruction in response to the latest “important” economic or corporate announcement.
Within a market environment in which animal spirits are rife and bouts of volatility a seemingly permanent fixture, maintaining a focus on the “big picture”, long-run fundamentals is, for us, imperative. In this regard, the deliberations at our annual strategy meeting, where our strategic “base case” is determined using forward return expectations for each asset class, based on prevailing valuations and the global economy’s position in the long-term cycle, are invaluable. This not only enables us to filter out the market noise that is a function of the aforementioned behavioural tendencies, but also identifies opportunities that arise from short-term dislocations that we can exploit through prudent tactical positioning.
I Just Can't Help Believin...
