Behavioral Economics | Does Data Tell You Anything About the Future?

“Economists were created to make weather forecasters look good.” – Rupert Murdock

While data centers are filled with information about the economy, the complexity of the interrelationships of the data make economic forecasting very difficult.

As a result, the forecasts of many economic models, regardless of their intricacy, become extrapolations of past economic data.  This tendency is reinforced by the human desire to blend into their peer group.  Therefore, economists rarely risk their reputations by making economic forecasts that deviate too far outside the “consensus” of economists.

If one’s going to be wrong, it’s better to be among a group that’s incorrect than to be singularly wrong all by yourself.

Because the economists’ consensus follows the trends of economic data, they are often wrong at economic turning points.  A well-known punch line is that “economists have predicted nine of the last five recessions.”

Is the Stock Market Predictable?

A discussion of stock market predictability must begin with consideration of time horizon and diversification.  For a large market basket of stocks, the longer an investor’s time horizon, the narrower the band of expected returns (as measured by the portfolio’s standard deviation)¹.  While this doesn’t make the long-term investor’s returns a certainty, it does reduce the magnitude of the potential error rate.

Because the path a stock portfolio will take over a long time horizon is unpredictable, it’s commonly characterized as a random walk;  As in, “The random walk of a drunkard.”

Looking for Patterns Where None Exists

The randomness of individual stock prices over short time horizons is incontestable.

Nevertheless, stock traders since the creation of public stock markets have looked at historical stock prices, attempting to make money by predicting the future path of stock prices.

The Securities and Exchange Commission (SEC) has good reason the require its ubiquitous mandatory disclosure, “past performance is not indicative of future results.”

There’s no new tradable information contained in stock prices.  Trying to time the market simply doesn’t work.

The first data interpretation shortcut that doesn’t work is one of reversal.  The Gambler’s Fallacy predicts a trend will end because it has occurred too often.  The simplest explanation of this is when someone predicts ‘tails’ because a fair coin toss has landed on ‘heads’ five times in a row.  This ignores the obvious, a tossed coin landing on heads is always 50% probability, regardless of the results of previous tosses.

Another trend predicting shortcut expects a continuation.  The Hot Hand Fallacy plays out when a basketball player or a dice thrower at a craps table goes on a winning streak.  Teammates will pass the ball to the ‘hot hand’ player, just as gamblers will bet the dice shooter’s streak will continue.  Unfortunately, luck is not predictable.

Sandene Strategies’ Investment Approach

At Sandene Strategies, our advisors are humble about financial markets and concede to the short-term volatility of stocks and the futility of trying to consistently beat the market.

Our investment philosophy is centered on each client’s risk tolerance and the time horizon of their long-term financial goals.

Rather than measuring relative performance against an index, we measure absolute performance against the goals in your financial plan.

We build investment portfolios and make periodic adjustments based upon our knowledge of behavioral economics and facts discovered through evidence-based investment research.

To discuss these ideas in more detail, shoot me an e-mail Jeff.Sandene@LPL.com or better yet, let’s schedule a conversation.

¹Morningstar Data – Ibbotson SSBI US Large Stock TR USD (1926-2025)

The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. Indexes are unmanaged and cannot be invested in directly.

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.