The Fourth Major Axiom : On Forecasts

The Zurich Axioms By Max Gunther

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Human behavior cannot be predicted. Distrust anyone who claims to know the future, however dimly.

Back in 1969, when the Consumer Price Index rose by about 5 percent, the consensus of leading economists was that the inflation rate would rise a bit in the early 1970s but then would taper off later in the decade. It didn’t. It doubled.

In 1979, when the index leaped by a scorching 11.5 percent, the consensus of the seers was that the rate would stay at double-digit levels through the mid-1980s. It didn’t. It was back down to 1969’s peaceful levels by 1982.

It makes you wonder. Why do we go on listening to economic prophets when they plainly know no more about the future than you or I?

We listen, no doubt, because knowledge of the future is, and has always been, one of the most desperately sough human goals. If you could read tomorrow’s stock prices today, you would be rich. And so we listen with respect and hope anytime somebody stands up and announces a vision of things to come.

More often than not, listening turns out to be a mistake. Back in the summer of 1929, on August 23, the Wall Street Journal told its readers they could make a lot of money in the stock market. The Journal’s special crystal ball, a future-gazing technique called the Dow Theory, revealed that “a major upward trend” had been established in stock prices. “The outlook for the fall months seems brighter than at any time”, the Journal warbled happily. A couple of months later, everybody went down the drain.

In more modern times, stock market guru Joseph Granville determined early in 1981 that stock prices were about to collapse. “Sell everything!” he instructed the thousands of disciples who subscribed to his advisory service. The expected collapse didn’t happen. The market seesawed through 1981. Granville remained bearish. The following year, 1982, saw the start of a spectacular bull market, one of the biggest and most sudden in living memory. People who got left behind by that market came to regret it earnestly.

Granville wasn’t alone in failing to foresee the bull market or in predicting its opposite. The year 1983 was a particularly dismal one for financial oracles. Consider the record of money managers – the professionals who handle ‘investment’ (or, as we would rather call it, speculation) for insurance companies, pension funds, and the like. In 1983, according to an estimate by the New York Times, three-fifths of these high-paid seers were so wrong in their guesses about the future that they made less money than would a novice speculator making choices by throwing dice.

The most commonly used measure of investment performance is Standard & Poor’s index of 500 common stocks. In 1983 this index rose some 22 percent. To put it another way, if you had a 22 percent gain on your speculative portfolio that year, you were doing average work. The performance would rate you a grade of C. According to the Times survey, 60 percent of money managers did worse than that.

There was one once-celebrated manager, for example, who predicted that interest rates would fall in 1983, so he invested heavily in bonds. Interest rates rose, and as a result the value of all those fixed-interest bonds plunged. The same man thought drug company stocks would rise, but they fell. He though projected changes in the telephone industry would be of particular benefit to MCI, so he loaded his clients’ portfolios with that company’s stock. It turned out to be a dog.

The fact is, nobody has the faintest idea of what is going to happen next year, next week, or even tomorrow. If you hope to get anywhere as a speculator, you must get out of the habit of listening to forecasts. It is of the utmost importance that you never take economists, market advisers, or other financial oracles seriously.

Of course, they are right sometimes, and that is what make them dangerous. Each of them, after being in prophecy business for a few years, can point proudly to a few guesses that turned out right. “Amazing!” everybody says. What never appears in the prophet’s publicity is a reminder of all the time when he or she was wrong.

“It’s easy to be a prophet”, the noted economic Dr. Theodore Levitt once told Business Week. “You make twenty-five predictions and the ones that come true are the ones you talk about.” Not many seers are that frank, but all would privately agree with Dr. Levitt’s formula for success. Economists, market advisers, political oracles, and clairvoyants all know this basic rule by heart: if you can’t forecast right, forecast often.

You can watch economists assiduously obeying this rule every year. Every June or July, the top prophets start issuing their solemn guesses about the first quarter of the year to come. The guesses usually deal with the big index numbers: the GNP, the inflation rate, the prime rate, and so on. Since they obviously study each other’s predictions with care, there tends often to be a remarkable uniformity in what they foresee. Many speculators base decisions on these guesses – and so do mighty corporations and the U.S. government.

Around September each year, the economic scene looks somewhat different, so the economists all come out with ‘revised’ forecasts about the coming first quarter.

Around November, things have changed still more, so we are treated to re-revised forecasts. In December .. well, you get the picture. Each oracle prays that at least one of his predictions will be right. The later ones are the more likely to be on target, since they are closer to the period being prognosticated, but occasionally one of the earlier forecasts hits the mark. This prophet will then make a virtue of the fact: “I foresaw this back in July!”

He will carefully avoid mentioning that his correct forecast was supposedly canceled and superseded by revised and double-revised predictions that he issued later on.

As for you and me, lone speculators trying to make a buck, we are well advised to ignore the whole ballet. If the June forecasts are going to be superseded by September ones, and they by still more sets in November and December, why listen at all? Accepting such a prophecy is like buying a ticket that is scheduled to expire before the play is performed.

Not all oracles have been able to organize the annual forecast-revising dance of the economists, but all are followers of the basic rule. They all forecast often and hope nobody scrutinizes the results too carefully.

It has always been thus. Michel de Nostredame, an obscure sixteenth-century French doctor, turned out hundreds of prophecies in the form of tangled four-line verses. He is known today by the Latin form of his name, Nostradamus, and is revered by a cult of believers. He is supposed to have predicted things such as air warfare and radio communication.

Well, maybe. The verses are in such indirect, mystical language that you can interpret any of them to prove anything you want to prove. Leaning over backward to be charitable to this ancient seer, I once studied a hundred of his prognostications and ended with the following statistical summary: three forecasts were correct, eighteen were incorrect, and the remaining seventy-nine were such dense gibberish that I simply didn’t know what the old Frenchman was driving at.

Not a very impressive record. Yet Nostradamus managed to make a name for himself in the world of prophecy – a name that any modern oracle would love to equal.

Nostradamus wasn’t often right, but he sure was often.

Or take a modern future-gazer, the self-advertised psychic Jeane Dixon. She is famed for some right guesses, principally one : a prediction of President Kennedy’s assassination. Amazing, right? Sure, but what isn’t so well publicized is a list of all her wrong guesses. According to Ruth Montgomery, Mrs Dixons’s biographer-disciple, the renowned clairvoyant predicted that Russia and China would unite under one ruler, that CIO chief Walter would run for President, that a cure for cancer would grow out of research begun early in this century, that ……..

Well, you see the point. The Committee for Scientific Investigation of Claims of the Paranormal, a scholarly group based at the State University of New York at Buffalo, studied Jeane Dixon’s record and found it to be no better than that of an ordinary man or woman making guesses.

It is easy to get dazzled by a successful prophet, for there is a hypnotic allure in the supposed ability to look into the future. This is especially true in the world of money. A seer who enjoys a few years of frequently right guesses will attract an enormous following – so big a following, in some cases, that the seer’s prophecies are sometimes self-fulfilling.

Such was the case with Joseph Granville, the stock market oracle. So many people wee basing decisions on Granville’s forecasts in the early 1980s that when he said something was going to happen, it happened because they believed it would. That is, when he said the market would go down, the prediction scared buyers out of the market – and lo, it went down.

This happened in early 1981, when Granville told his disciples to sell everything. The day after this famous warning was issued, the stock market fell out of bed – 23 points on the Dow. All of Wall Street said ooh and ah. What a powerful prophet was this Granville! The plunge was brief but impressive while it lasted.

If you had then been a student of the Zurich Axioms, it might have seemed to you that here was an exception to the teaching of the Fourth Axiom. Though most prophecies aren’t worth two cents, might it not be a good idea to put one’s money on a seer like Granville? If his forecasts are self-fulfilling, aren’t you all but sure to win by doing what he recommends?

No. Not even self-fulfilling prophecies self-fulfil reliably. Later in 1981, Granville launched another test of his prophetic power. His crystal ball told him the market would plunge again on Monday, September 28. He announced this to he world. Some speculators sold stock short or bought puts on the strength of it. They, like Granville, were convinced the plunge was coming.

Instead, the New York Stock Exchange that day scored one of the biggest price gains in its history, and a day later, markets in Europe and Japan followed suit.

Some of Granville’s followers were baffled, but they need not have been. They had merely had it demonstrated to them that Granville is like anybody else: he wins some and he loses some.

Every prophet is right sometimes and wrong sometimes – more often the latter, but you can’t tell in advance which it is going to be. To be in a position to tell, you would have to make predictions about the prophet’s predictions. If you were that good at predicting, you wouldn’t need the prophet. Since you aren’t that good at it, you can’t count on anything the seer says. So you might as well forget the whole fruitless exercise of trying to catch a glimpse of the future.

Let’s look at another example. Back in 1970 a financial editor, columnist, and oracle named Donald L. Rogers published a book entitled How to Beat Inflation by Using It. This book was notable for containing the magnificently wrong advice that one should not buy gold. However, we can forgive Rogers that forecasting failure. Gold was a common blind spot in crystal balls of the time. What is more interesting is this prophet’s listing of common stocks that he thought would do well in the year ahead.

Rogers reasoned that land would a good hedge against inflation. Therefor, he figured, it would be a good idea to buy stocks of companies that owned a lot of land. He listed stocks to buy on that basis.

Some of his recommendations have turned out pretty well in the years since. Warner Communications, for instance. If you had bought this stock in 1970, you could have sold out at a handsome profit at various times until trouble struck the company in mid – 1983. Other recommendations on Roger’s list, such as ITT, have turned out miserably.

The question is: if you had read Roger’s survival manual in 1970 and accepted some of his prognostications, how would you have fared?

Well, it would have depended on your luck. If you had picked winners from his list, you would have won, and if you had picked losers, you would have lost. Luck was in control of the outcome all the time. That being so, one can ask what was the sense of listening to the prophet in the first place.

It may seem unfair to pillory Rogers and other oracles on the basis of hindsight. It is easy, after all, to sit here today and say what was and wasn’t a good speculation in the 1970s. A prophet might be excused, perhaps, for challenging me: “See here, Gunther, what gives you the right to catalog all our wrong guesses? Could you do better? Are you such a hot prophet?”

Ah, a good question. No. I’m not a prophet, and that is just the point. I’ve never made any serious attempt to read the future (though of course I’m always wondering about it), have never spent many pages saying it can’t be done. But the people we’ve been criticizing here are men and women who claim they can see ahead. They have set themselves up as oracles, they accept money for their prognostications, and they are aware, or should be, that there are people who reach important decisions on the basis of what they say. It seems perfectly proper, therefore, to hold these prophets accountable for what they predict. If they are selling a prediction service, we have a right to subject that service to critical scrutiny and find out how good it is.

The conclusion is that it isn’t very good. You cannot profit by listening to a prophet.

There are things that can be predicted. We know precisely when the sun is going to come up each morning, for instance. Tide tables are prepared months ahead. The free calendar I get each January from the bank says what the moon’s phases will be throughout the twelve months ahead. Weather forecasts are less precise but still are reasonably trustworthy and getting more so.

The reason why such things can be predicted, and why the predictions can be trusted, is that they are physical events. But the Zurich Axioms are about the world of money, and that is a world of human events. Human events absolutely cannot be predicted, by any method, by anybody.

One of the traps money-world prophets fall into is that they forget they are dealing with human behavior. They talk as though things like the inflation rate or the ups and downs of the Dow are physical events of some kind. Looking at such a phenomenon as a physical event, an oracle can understandably succumb to the illusion that it will be amenable to forecasting. The fact is of course, that all money phenomena are manifestations of human behavior.

The stock market, for example, is a colossal engine of human emotion. Prices of stocks rise and fall because of what men and women are doing, thinking, and feeling. The price of a given company’s shares doesn’t rise because of abstract figures in an accounting ledger, nor even because the company’s future prospects are objectively good, but because people think the prospects are good. The market doesn’t slump because a computer somewhere determines selling pressure is on the rise, but because people are worried, or discouraged, or afraid. Or simply because a four-day weekend is coming and all the buyers are off for the seashore.

It is the same with all those grand index numbers economists love to play with: the GNP, housing stats, inflation rate. All are the results of human interaction, men and women striving restlessly in the eternal battle for survival and self-betterment. And it is the same with the end results of those index phenomena fermenting together: recessions and recoveries and booms, good times and bad. All are caused by people. And as such, all are entirely unpredictable.

There are simply too many unknowable variables involved to allow for trustworthy forecast of something like the inflation rate. The rate is caused by millions of people making billions of decisions: workers about wages they want to be paid, bosses about wages they are willing to pay, consumers about prices they will swallow, everybody about diffuse feelings of hardship or prosperity, fear or security, discontent or buoyancy. To claim you can make reliable forecasts about this staggering complexity seems arrogant to the point of being ridiculous.

As the Axiom says, human behavior cannot be predicted. Since all money-world forecasts are about human behavior, you should not take any of them seriously. Taking them seriously can lad you into many a dark and gloomy valley. The stock market probably offers some of the most start examples. To pick one at random, consider the Value Line Investment Survey’s 1983 forecast about the Apple Computer Company.

Value Line sells a regular oracular service in which it periodically rates stocks for what it calls ‘performance’ over the coming twelve months. In other words, it gazes into the future of each stock and says what it thinks will happen to the stock’s price in the year ahead.

It must be said that Value Line’s record has been pretty good in most recent years. However, we are up against the same problem we discussed in connection with Donald I. Rogers and his list of stocks to buy in 1970. If you were a Value Line subscriber and accepted the forecasts as gospel, your personal financial fate would depend on whether you were lucky enough to act on the good prophecies while passing the bad ones by.

And there sure have been some bad ones. One of the most spectacularly bad was the prophecy about Apple Computer.

On July 1, 1983, Value Line published a list of “Selected Stocks for Performance”. One company on this elite list was Apple. Its shares were then trading in the neighborhood of $55.

A few months later they were down to $17.25.

The debacle was caused, of course by events that Value Line could not foresee in July. An oracle can always cry “unforeseeable events” in explanation of a forecast that turns out wrong. But that is just the trouble. Every forecast has the possibility of unforeseeable events ahead of it. No forecast about human behavior can ever be compounded of 100 percent foreseeable events. Every prediction is chancy. None can ever be trusted.

Many of those who bought Apple in July 1983 must have sold out before it hit bottom. Some, acting according to the Third Axiom, may have jumped ship with only minor losses. But there are situations in which such early abandonment isn’t possible. A bad forecast can, if you aren’t wary, get you trapped in a losing proposition for years.

Consider all the poor folks, for example, who bought long-term certificates of deposit from banks in the early to middle 1970s. As we noted earlier, economists had predicted that interest rates would rise at the beginning of that decade and then level out or taper off. The first part of the prediction turned out right. Rates rose. Banks began offering four-year and six-year CDs with unheard-of interest rates like 7 and 8 percent.

To earn those huge rates – huge as seen from the viewpoint of the early 1970s – you were, of course, required to kiss your money goodbye for the stated number of years. You couldn’t withdraw it except by special arrangement and under pain of a stiff penalty. How did bankers get people to let their money be locked up like that? The bankers did it by reiterating the economists’ prediction.

“Look, you’re gonna miss 7 percent!” a banker would tell a prospective depositor couple, standing there with their life savings clutched in trembling hands. “Where did you ever hear of a rate like that before? Can you imagine getting more? It’ll never happen! What you want to do is grab it while you can get it. All the top economists say rates will go down next year or the year after, and our own people agree. Lock in that 7  percent and you’ll be sitting pretty!”

It sounded great. Until the prediction turned out wrong.

Rates went up to levels that nobody had ever dreamed of before. By the end of the decade, banks were offering six-month CDs with rates in the eye-popping range of 10 and 11 percent.

Those high-paying six-monthers were very popular. A lot of people wanted them. Including many whose money was serving a six-year sentence at 7 percent.

Speculative Strategy

The Fourth Axiom tells you not to build your speculative program on a basis of forecasts, because it won’t work. Disregard all prognostications. In the world of money, which is a work shaped by human behavior, nobody has the foggiest notion of what will happen in the future. Mark that word. Nobody.

Of course, we all wonder what will happen, and we all worry about it. But to seek escape from that worry by leaning on predictions is a formula for poverty. The successful speculator bases no moves on what supposedly will happen but reacts instead to what does happen.

Design your speculative program on the basis of quick reactions to events that you can actually see developing in the present. Naturally, in selecting an investment and committing money to it, you harbor the hope that its future will be bright. The hope is presumably based on careful study and hard thinking. Your act of committing dollars to the venture is itself a prediction of sorts. You are saying, “I have reason to hope this will succeed”. But don’t let that harden into an oracular pronouncement: “It is bound to succeed because interest rates will come down.” Never lose sight of the possibility that you have made a bad bet.

If the speculation does succeed and you find yourself climbing toward a planned ending position, fine, stay with it. If it turns sour despite what all the prophets have promised, remember the Third Axiom. Get out.