Life is full of uncertainties and choices, so we struggle to predict what lies ahead and what it would be like if we take actions. If we cannot fathom the secrets in the making, seeing the whole picture of economy will be too overwhelming for us to tackle alone. Hence, we need professional advice.
But, here is a problem. When forecast arrive on the scene, whom and what should we believe?
In the book Fortune Tellers the Story …of America’s First Economic Forecasters, Walter Friedman offers a deep perspective on this issue by tracking back to the USA’s first economic forecasters. He notes that economic forecast is nothing but an autonomous economy that followed decipherable rules.
These empirical approaches to economy created econometric models, along with ideas of how to conceptualize the economy. And, this explains why we have founded so many institutions to analyze the past as well as forecast the future.
Many financial advisors rely heavily on business cycle, they know the client would feel more comfortable about investment plans if they catch the internal rhythms of economy. It is just like sailing ships in the tide, the feeling of not knowing where we are going would kill us. This is why a bunch of experts would gather data and send out newsletters to render the financial outlook to their entrepreneurial advantages.
That is the way a lot of people tend to think about the economy these days. When seeing the stock market, for instance, going way up, your mind tells you that it is probably going to come down a similar amount and reach some kind of normal level. And that was Babson’s Chart, a beautiful red and black chart that shows how areas of boom and bust will equal out over time.
How much growth would you expect from investments? Babson’s chart has a trend line driving through the curve. And that was the estimated normal growth rate of about 3% per year. Therefore, for those who cannot take too much risk, it would be a great tool for making investments.
On the contrary, Irving Fisher became a rival of Babson in analytical approaches to economy. As a trend analyst, Babson really believes in trends over a long period of time. Just the opposite, Fisher does not think trends are important at all. Instead, he believes in causation and tries to figure out how the economy works and the effects are entailed. What effect does it have if we plow earnings back? What effect does it have if we pour dividends back in to earnings? Fischer tried to find ways to quantify these changes and the effects they would exert. His perspectives corroborate econometrics and foster the idea of mathematical approaches to forecasting and to make sense of econometrics.
The big move in forecasting that really has made a difference, is the transition from the idea of a fixed business cycle, to one in which certain actors like the government may flatten cycles.
Once you start believing that cycles are not something simply happens to an economy, but are ones that government can make a difference in, this mindset may carry a risk of over-confidence.
The real problems that people have with forecasting is that they tend to look at past accuracy as an indication as to whether or not to follow a forecaster.
Without trying to figure out the reasons behind forecast, investors are probably going to fall for a financial advisor as Walter Friedman explain in the book:
“I think you need to think about forecasts a bit like a treasure maps. In that you always have to be skeptical of the person who would want to print and sell treasure maps on mass. When it’s much better for you to simply keep a treasure map, if you actually have a valid one, and get the treasure yourself. You have to keep in mind that these people are trying to sell their predictions. And that persuasion is as big a part of this industry as prediction is.”
Therefore, having a financial advisor does not make investors exempt from doing research.