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Why You Should Listen to Economic Forecasts With Caution

James Paulsen, Diane Swonk and David Winters are all pretty smart people. And when they talk, people listen. The advice they give sounds intelligent and logical, and their opinions on the direction of the market are certainly worth reading for entertainment value. There's only one problem: There's no evidence to suggest they can foresee the future any better than palm readers, crystal ball gazers, tarot card readers or astrologers.

William Sherden, author of a book I highly recommend, The Fortune Sellers, researched the records of economic market forecasters. The following is a summary of his findings:

  • Economists can't predict the turning points in the economy. Of 48 predictions made by economists, 46 missed the turning points.
  • Economists' forecasting skill is about as good as guessing. Even the Federal Reserve, the Council of Economic Advisers and the Congressional Budget Office had forecasting records that were worse than pure chance.
  • No economic forecasters consistently lead the pack in forecasting accuracy.
  • No economic ideologies produce consistently superior economic forecasts.
  • Increased sophistication provides no improvement in economic forecasting accuracy.
  • Consensus forecasts offer little improvement.
What's most interesting to me is that if asked whether you should take the advice of Warren Buffett or that of Paulsen, Swonk or Winters, I would venture that all but those three and perhaps their respective spouses would choose Buffett. Here's what Buffett had to say about the value of market forecasters:

"We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, (Berkshire Hathaway vice chairman) Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children."

The historical evidence is overwhelming that investors are best served by ignoring market forecasts. The winning strategy is to adhere to your well-designed investment plan formalized in an investment policy statement. It's also important to remember the words of Laurence Peter: "An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today."

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