By Dan Brocklebank

As tempting as it may be to predict the future, history shows that many investors have an abysmal track record in doing so. The book Dow 36,000 – published in 1999 near the peak of the TMT bubble – stands out as an egregious example. The authors argued that since there had never been a negative 10-year holding period for a diversified basket of large cap US equities, stocks and bonds should be treated as equally risky.

Viewed this way, “the old limits of yields and P/E no longer apply”. So much for that. Three years after publication, the S&P 500 was down 40% and by 2008 the index had registered its first negative 10-year holding period.

Of course, Dow 36,000 might be forgiven as a clever way to sell books rather than a professional forecast, but a more comprehensive look at the data suggests that economists and financial analysts don’t do much better with their respective predictions. When we looked at 20 years of survey data from the Federal Reserve Bank of Philadelphia and compared expert predictions for inflation, corporate earnings and US Treasury yields with the subsequent actual results, we found that the “experts” did a fantastic job … at predicting the prior year’s results.

Why do they get it so consistently wrong?  The short answer is that we are all human and our brains are hardwired with biases that make us remarkably poor forecasters. For example, we tend to draw conclusions from recent history and then extrapolate them. While that’s perfectly sensible as an evolutionary survival mechanism, it can lead to terrible investment decisions.

Consider another infamous forecast: the August 1979 cover of BusinessWeek magazine proclaiming the “Death of Equities”. In 1979, with US inflation running at double-digit rates, it may have seemed perfectly rational to seek comfort by following the herd into gold and commodities, assets which stood to benefit the most from prevailing trends. While there was little reason to believe that the Federal Reserve would step in and tame inflation, that’s precisely what happened under Paul Volcker’s leadership. As a result, US stocks and bonds went on to be phenomenal investments in the ensuing decades while gold and commodities plunged into a prolonged bear market.

Although, forecasting is extremely difficult, and unreliable as an investment tool, it should be noted that there is one investment method that is nearly fool-proof over the long term: valuation. The exact timing is highly uncertain, however the price that one pays for an asset is (eventually) the most reliable predictor of future returns. That’s because even the most irrational investor behaviour cannot permanently overpower the relationship between price and intrinsic value. Investors who paid more attention to the latter rather than extrapolating past trends would have avoided chasing internet stocks at their peak and would have loaded up on stocks in the late 1970s.

We will resist the temptation to end with forecasts of our own, but would note that there are areas of the market that seem both attractive and vulnerable today from our perspective as value-orientated, bottom-up investors. These include selected shares in the energy sector, where pessimism remains unusually high and markets such as Korea and Russia, which are deeply out of favour with many investors. On the other hand, we fear that the apparent “safety” today of certain investments, most notably government bonds, may prove illusory with yields near record lows in many developed markets.

Investing is all about taking decisions about how an uncertain future will unfold.  Forecasts, therefore will always be superficially appealing, particularly those made confidently by ‘experts’, because they appear to eliminate or reduce that underlying uncertainty.

Given the lousy track record of forecasters in general, don’t let them seduce you into complacency and over-confidence. Focus on what you can actually measure.

Dan Brocklebank is an equity analyst at Orbis Investments and director at Orbis Access UK 

By David Lloyd

From predictions of economic growth to a view of future gilt yields, institutional investors are conditioned to follow forecasts and invest in the expectation of outperformance. And forecasting the future is a widespread activity among credit investors seeking an extra edge, particularly in fully valued fixed income markets.

But the problem with forecasts is that they are an absurd notion. The global financial and economic system is bewilderingly complex; no amount of crystal ball-gazing can generate consistently accurate assessments of what will come to pass 12 months from now.  For example, in December 2013 economists’ consensus forecast for 10-year gilt yields at the end of 2014 was of 3.2%. For the following 11 months, 10-year gilt yields averaged 2.6%, dipping below 2% in October.

One might think that central banks would be a good source of reliable forecasts, given the centrality of forecasts to their setting of monetary policy. And yet central banks are not, in fact, very good at producing consistently useful forecasts. Nor should they be, I would argue. This is absolutely not a criticism; I merely contend that it can’t be done.

It appears that central banks are themselves facing up to this. The Federal Reserve and The Bank of England both now talk to about ‘trigger levels’ for policy response. For example, Mark Carney announced a series of economic triggers, such as unemployment falling below 7%, which could cause base rates to rise. To me, this is a tacit admission that they will no longer rely primarily on forecasts in order to set monetary policy.

If the most scrutinised forecasters, with access to the widest and deepest range of information, struggle to predict the future, and if we accept that we have no reliable insight into what is to come, then what is really important for investors to consider? The answer is value, and the critical question in searching for it is: where is risk adequately rewarded, and where is it not?

Taking this as a starting point, a resulting ‘bottom-up’ approach to investment in credit enables investors to buy and sell based solely on value opportunities in the market. It responds to events rather than trying to predict them and thereby focuses investment decisions on what is knowable (facts), not on the unknowable (the future). This approach is certainly resource-intensive (it takes manpower and deep credit research capabilities to assess each opportunity) and it requires patience (there are times when markets do not present many opportunities where risk is adequately compensated). But all our experience shows that patience is rewarded, and the approach delivers repeatable, sustainable excess returns.

So, for credit investors, there are really two follies of forecasting: one, that it can be done and two, that it is needed.

For investors who eagerly await the plethora of investment outlooks for 2015, remember that forecasters not only need to get it right once, but to repeat their successful forecasts year after year. As Niels Bohr, Danish physicist and Nobel Peace Prize winner, surmises so succinctly: “Prediction is very difficult… especially if it’s about the future.”

David Lloyd is head of institutional public debt at M&G Investments