When half-right market forecasts are disastrous

In many other endeavors outside of investing, getting a forecast half-right isn't quite the end of the world. In asset allocation, however, half-right can be a killer.

Lori Shepler/Reuters/File
The headquarters of investment firm PIMCO in Newport Beach, Calif., last year. According to Brown, PIMCO's incorrect prediction that the stock market would fail to rally back after the recession is still costing investors who took it seriously.

PIMCO got it half-right with its New Normal forecast early in the post-crisis period - they nailed the economic environment we'd be in but completely missed one of the top ten stock market rallies of all time.

Barry Ritholtz has been writing about the Follies of Forecasting since before I was born, see this landmark 2005 piece on the subject at TheStreet.com. By the way, Barry's chutzpah to publish something like that in the pre-blog era - on a site rife with daily predictions - was quite extraordinary at the time.

In many other endeavors outside of investing, getting a forecast half-right isn't quite the end of the world (cloudy with a chance of showers doesn't upset anyone if the clouds arrive without any rain). In asset allocation, however, half-right can be a killer.

Here's John Rekenthaler at Morningstar:

"There was the New Normal argument, as advanced by PIMCO and Bill Gross. The main prediction of the New Normal was economic: The U.S. economy would not roar out of the 2008-09 recession, as is expected during recoveries, but would instead trudge along at only a modest pace. That analysis was spot-on and has earned PIMCO much-deserved credit.

The secondary prediction of the New Normal concerned investments: That stocks would have a lower rate of return in the future, and that stock investors would not automatically succeed by buying on dips. That analysis has been wrong--very wrong. Stocks have had a spectacularly high return since Gross wrote those words, and buying on the few dips has been profitable indeed. In short, 1) the New Normal thesis never directly said that buy-and-hold is dead, and 2) even if it did, nobody should overhaul an investment approach based on the stock-market predictions of a bond economist."

Which was more important to have gotten right? Only an economic theorist or policymaker would say the former, for everyone else with real-world needs and concerns, the miss on the second part of the forecast has been annoying to disastrous, depending on how seriously it was taken by investors.

For those who took it to extremes, the opportunity cost has been tremendous and emotionally exhausting, not to mention all of the over-excited buying and selling and taxation and brokerage commissions larded on in the name of "managing risk".

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