The Madness of Forecasting

A national championship, no electricity for miles around, and a dead teenage classmate.

What happened?

Forecasting failed us.

Weather Forecasting

Weather forecasting is notoriously fickle (here’s another article on the topic.)

Forecasts more than 8 days in the future are not worth looking at. They hold no water. The weather is too dynamic. Too much can change in the next week. Forecasts greater than one week out are only as accurate as the Farmer’s Almanac (which is to say, not accurate at all).

A small upswell off the coast of Africa can magnify over three weeks and crush Miami with a hurricane.

If the upswell was bigger, the hurricane hits Jamaica instead. If the upswell was smaller, there is no hurricane.

Small changes in input equal huge differences in output. Forecasting that is impossible.

April 2003

On April 1, 2003, my friends and I were excited. The Syracuse University men’s basketball team had just qualified for the Final Four. We waited in anticipation for the weekend.

But then a peculiar weather event swept over us.

Towns west and south of us were soaked with hard rain. Those east and north of us were blanketed with snow.

But a small area around my town was hit with “freezing rain.”

The air up high was too warm for snow to form. But the air down low—and all the surfaces down low—were below freezing. As soon as the raindrops struck a surface—a tree, a car, the roads, the powerlines—they froze.

Such a peculiar event is impossible to forecast a week in advance. The weather conditions have to be juuuuuust right. Too warm, it’s all rain. Too cold, it’s all snow.

But we were the unlucky Goldilocks. Not too hot, not too cold. The rain fell and the ice built up, half-an-inch on every surface.

I remember waking up to thunderous CRAAAAAACKS coming from the woods. Tree limbs were being torn from their trunks, laden too heavy with ice.

Everyone in town lost electricity, mainly from trees falling onto powerlines.

Thankfully, my family had a generator to keep the essentials (e.g. the refrigerator) powered. We warmed water on the woodstove. We were fine.

And we watched Syracuse play for the national championship on the generator-powered TV.

Nobody Picked Syracuse

Syracuse got lucky.

Their best players were two freshmen (Gerry McNamara and the now-famous Carmelo Anthony) and a sophomore (Hakim Warrick). They were inexperienced.

They played poorly in their “Sweet Sixteen” tournament game against Auburn and deserved to lose. But they snuck through and won 79-78.

Then in the Elite Eight, Syracuse played #1 seed Oklahoma, who were far better (on paper) than Syracuse. But Oklahoma couldn’t figure out how to beat Syracuse’s famed “2-3 Zone” defense. ‘Cuse stifled the Sooners and won easily.

The same script played out in the Final Four game against another #1 seed, Texas. Syracuse’s defense was too good.

And in the national championship against powerhouse Kansas, Syracuse’s Gerry McNamara hit six 3-pointers in the first half. Kansas was stunned. And despite Kansas’s best efforts, Syracuse held on to their big lead and won their first national title.

We joyfully watched from inside our dark, quiet house, with the generator’s muffled whirr coming from the backyard.

It was March Madness. Three weeks earlier, nobody thought Syracuse would win. Nobody saw it coming.

Back to the Ice Storm

My classmate Scott had a generator too.

Generators, like all gas-powered engines, give off nasty fumes. Some even toxic. One of those fumes is carbon monoxide. It’s odorless and deadly.

In a moment of tragic miscalculation, Scott’s family put their generator in the garage. Carbon monoxide slunk under their door and into the home. Scott and his stepmom died in their sleep. Terrible, terrible.

I spoke to him in school just a week before. He was 13 years old, like me.

I stacked ice-covered branches and grew up and now write to you 19 years later. Scott didn’t get to do any of that. All because of a hyper-local ice storm that nobody forecasted.

Forecasting Markets

Today’s lesson, of course, also applies to investing.

I just read a great article from Joe Wiggins. One of his best lines is:

“One of the problems of market forecasts is that they are so easy to make. That they can glibly roll off the tongue, belies how fiendishly complicated the activity is. When we see or hear one, it is worth taking a step back and thinking through exactly what foresight is being claimed and quite how absurd it is to believe that anyone possesses it.”

Joe Wiggins, BehaviouralInvestment.com

Both experts and non-experts love to make market forecasts. They predict how the market will react to news out of Ukraine. They anticipate market reactions to changing interest rate policy.

But there’s little evidence to suggest anyone can consistently forecast correctly.

Markets are too complex, too dynamic, too fickle. They’re not based on physics (like the weather), but instead based on a combination of economics (semi-rational math) and the psychology (via irrational brains) of millions of market participants.

When you lose a coin flip, you don’t ask, “What did I do wrong?” It’s a coin flip. It’s random. It’s not about you.

But too often, that’s precisely what investors ask themselves when the markets don’t behave as they’d hoped.

Market predictions are two-thirds coin-flipping, one-third chess. Some skill, but mostly luck.

Too often, however, investors convince themselves it’s all skill. Their wins? Due to skill, of course. Their losses? Due to an objective truth they missed, with a skill-based lesson they can now learn.

“Just as we are almost never 100% wrong or right, outcomes are almost never 100% due to luck or skill.”

Annie Duke

Many investors ignore the fact that their wins and their losses are predicated on factors they neither considered, predicted, nor controlled. It’s randomness.

In the long-term, markets are predictable, but only coarsely. I can reasonably predict that the S&P 500 will grow over the next 20 years. Similarly, I can predict that this summer will be hot.**

**Although…could a volcano darken the global sky and bring snow in July? Yes. It’s happened before. Could a cataclysm (economic, man-made, or natural) lead to decades of economic recession? Yes, it could. It’s impossible to forecast.

This isn’t ground-breaking stuff, you see? I’m zoomed way out. Suggesting that summer is warm barely qualifies as a prediction.

But will it rain on July 8, 2022? I have no idea. Will Apple, Amazon, Microsoft, Google, and Tesla be the biggest 5 companies in 20 years? Again, I have no idea.

Because a lot can change in a few decades. Morgan Housel recently spoke with Tim Ferriss and said,

“1900 was horse and buggy and 1950 was rockets and atomic bombs. 

One of the things that sticks out from that too, that comes up again and again is just the extent that no one saw what was coming. No one saw it coming. What actually happened, no one saw that coming.

And even if you look at the dawning of these big events, like World War II and the Great Depression, nobody saw them coming. It seems so obvious to you and I today, if you research what happened during the 1920s and what happened in 1929, the glorious roaring ’20s and the stock market bubble, it’s easy to be like, of course it all ended in calamity. But people were not saying that at the time, and the few people who did say, “Hey, this was probably dangerous,” were completely pushed aside.

Same with the period right before World War II and the aftermath of World War II, and the technologies that came out of the Cold War, again and again, the repeating theme among the story is that people didn’t see it coming. And that just gives the reader so much humility when you’re looking at today that you and I, and everyone else, and the smartest people that we know have no clue what’s going to happen over the next 10 years. That’s always been true and I think it always will be true.”

Morgan Housel

As we drive through life, the rear-view mirror has perfect clarity. But the windshield is socked-in with fog.

It will be true of this year’s March Madness basketball.

It’s true of the weather.

It’s true for your friends, loved ones, and the people coming into and out of your life.

And it’s true in the financial markets.

Forecasting is hard. Sometimes impossible. Always maddening.

Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.

-Jesse

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