Thursday, May 20, 2021

Is Forecasting Futile?

Warren Buffett has a lot of insightful quotes about pretty much any investment situation you could think about. One of them covers forecasting. 

“Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”

I recently saw a chart, which showed the future forecasts for the Federal Funds rate. These are based on futures contracts traded on Futures Exchanges. 


As you can see from the chart, these forecasts are often very wrong, and very off base. Which is why you should always take forecasts with a huge grain of salt.

If you look at the analyst estimates for S&P 500 earnings over the past 25 years, you can see that estimates are off quite often. They usually start as being too optimistic, until they gradually decrease to the a lower amount. It is fascinating to observe that in only five out of 25 years did estimates on S&P 500 earnings actually turn out to be more conservative than reality ( a positive surprise).

For 20 out of 25 years in question, the analysts were too optimistic and actual earnings were lower than forecasted ( negative surprise).


The point is that you should always take anyone's opinion or estimates with a grain of salt (mine too). Usually, doing your own research should provide you with enough conviction to pursue your investment strategy, and ignore the noise. Having a proper risk management process is very important, because no-one is right 100% of the time. Hence, it is important to lose little when you are wrong, but maximize profits when you are right.

In my investing, I try to focus on major trends and themes, which have an underlying logic behind them. For example, I agree with Peter Lynch that if you spend more than 13 minutes per year worrying about macroeconomic indicators such as interest rates, you have wasted 10 minutes. 

Instead, I try to focus on individual businesses that have certain characteristics such as moats, brands and intangibles that keep their competitors at bay. Some of these businesses also serve basic human needs, which means that demand for them is less cyclical and more recurring in nature, which bodes well for revenues, earnings and dividends. I am pretty confident that people would eat junk food, drink alcohol, smoke, fight wars, wash hands, brush teeth, wipe, use spices, use cosmetics, car for their pets, make trash, pay for phones, pay for medicine etc

On the other hand, I don't think that even the person in charge of the Federal Reserve has a clue about where rates would be three months from now.

I’ve had this idea for a while, but may also have been inspired by this investor, “ Eat them, drink them, smoke them portfolio”.  

So, you're going up to New York and do that fancy book learning?" And I said, "Yes sir."

He responds by saying, "You don't need any of that. I'll tell you everything you need to know in one sentence."
I started thinking to myself "alright, here it comes.”

He says, "Eat 'em, drink 'em, smoke 'em, go to the doctor, and look good when you get there."

I just looked at him, so he says, "Alright, I know you're a little slow so I'll repeat it. Eat ‘em - Your food
companies. Drink 'em - Your beverage companies (soda, milk, juice, beer, hard alcohol). Smoke 'em - Your tobacco companies. Doctor - Your healthcare companies.

He pauses for a second and says, "You're engaged aren't you. Let me tell you something about your future bride." I started thinking to myself you've never met my fiancée. He says, "She's going to allow the house to burn down around her before she goes out in public without her hair and nails being done. So that's my last category; cosmetics, beauty supplies.

Then he said, "Listen, if you invest in those categories, you're never going to be the most popular kid at the cocktail party. But you're also not going to blow up your clients.”
In a way, my strategy for investing is expecting that people would be people, and they will stick to their behaviors over time.

It also means identifying riding long-term trends and sticking to them for as long as they remain in tact. This is how a rising dividend payment after several years in a row helps me identify a trend that I can invest in, and I stay invested for as long as it is ongoing ( the dividend is rising and not being cut). I do not know how long a trend would continue for, but I do know to hold on for as long as possible. That way I do not make predictions, but ride long term trends as they are ongoing.

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