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And the forecast is for...

Here in Georgia where I live, we got six inches of snow yesterday morning. Very unusual for this part of the country. But the weather forecasters were dead-on in their predictions, so we were prepared and are now cozy here with plenty of provisions and, if need be, a back-up source of heat.

The folks who forecast weather for a living are usually pretty accurate (probably because they're dealing with events only a few hours or days away). Regrettably, the same can't be said for those who forecast the economy and the stock market, as the Wall Street Journal's Jason Zweig points out.

Every January, hordes of highly paid experts attempt to predict what the economy and the markets will do in the coming year. Later in the year, nearly all of the forecasts turn out to be wrong....

Why do people with years of experience, massive expertise and mountains of data at their disposal so often get the future wrong?

First and foremost, the future is the realm of surprises; no one, no matter how expert, can reliably foresee what will happen and how people will react to it. As the economist Friedrich von Hayek said in his lecture "The Pretence of Knowledge" when he won the 1974 Nobel prize in economics, "in the study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process…will hardly ever be fully known or measurable."

Forecasts also go wrong because they tend to be either too tame or too extreme. For a forecaster, there is little point in differing slightly from the consensus prediction. No one gets fired for being in the middle of the pack, nor do forecasters get much credit for being a little bit less wrong than their peers. If a forecaster is going to deviate from the average, he might as well go all the way.

Therefore, while most pundits tend to cluster around a safe consensus, a few stake out the risky but potentially lucrative ground of extremely bullish or bearish predictions. If they turn out to be right, their accuracy will seem miraculous and they will be famous; if they turn out to be wrong, most people will forget.

Jason Zweig offers a few ideas for getting some practical use out of usually errant forecasts, such as averaging various forecasts ("errors will frequently offset one another," he says). But in the end, despite all the complex formulas and computer modeling forecasters use, financial forecasting comes to down to trying to predict the unpredictable.

Zweig's ends his piece by quoting G.K. Chesterton:

"The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite.… It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait."

Because no one can know the future, we always urge you to keep your stock portfolio well-diversified and your bond portfolio (if any) as insulated as possible.

After all, no one knows what kind of inexactitude and wildness may lie just around bend.

Yesterday on The Meeting House from Alabama's Faith Radio, I talked with host Bob Crittenden about the difficulty (if not impossibility) of making consistently accurate market predictions. You can listen to a portion of that interview below (14 min.).

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