Barron’s Grades on a Curve
Didn’t you love those classes in high school and college where the professor on the first day of class would disclose the fact that he or she “may sometimes grade on a curve”? In other words, as a student, my performance benchmark was not necessarily my absolute performance in terms of my score on an exam. Rather, I just needed to outperform my peers by a sufficient amount to end up at the high end of the distribution of scores in order to get a decent mark.
Well, it appears as if Barron’s magazine grades on a heck of a curve. Each year, Barron’s engages any takers in a forecasting challenge. Questions range from economic to financial to political, and are mostly multiple choice, with a couple fill in the blanks. Examples of questions in the 2006 challenge are “Which US equity index will fare the best in 2006?” and “What will be the top performing commodity in 2006?” You can find the article here.
Without reading the article, how many questions of the 21 asked would you suspect one would need to have answered correctly to win the competition? The answer: 11. The winner of the competition, a retired engineer from the Midwest, answered 11 questions correctly out of 21 possible. The average for all 1,700 participants was 5 correct out of 21 possible. Is this statistically possible for a test which is predominantly multiple choice with the sample of test takers presumably being well informed on the material being tested? In fact, when I heard the results of this challenge being discussed on a the local NPR affiliate, the anchor answered the question regarding commodities correctly despite a self admitted complete lack of knowledge on the commodities market. She quickly followed her correct answer with a statement along the lines of, “Just shows you how much you need to know about this stuff to make a living at it”. Oh, if only it were so.
Let me be clear - I am by no means claiming that I could have done any better than the average of 5 correct. It may even be generous of me to assume that I would have hit the average. What this highlights, however, is the incredible difficulty involved with the task of forecasting. Let’s face it, forecasting involves making assumptions about the future state of things, which no person can do with an absolute certainty. All we can do is digest what we know to be true currently, and stress test our assumptions about the future for any of several unknowns. Obviously, the farther out in time one goes, the more difficult forecasting becomes. Ever hear of a 10 week weather forecast? How about a company offering earnings guidance for the first quarter in 2020?
We understand the inherent difficulty in pinpointing the direction and/or magnitude of future events in the financial marketplace. Our approach to dealing with this inherent uncertainty involves establishing small positions in our clients’ portfolios with a high probability of success and not placing our forecasts too far out into the future. By keeping our time frames short, by keeping our “bets” small, we allow ourselves the room we feel is necessary for risk management should the unexpected come to pass. Risk management is by far, the most important (and most difficult) ingredient to long term investment success, in a world where no one really knows what will occur in the future, as demonstrated by the Barron’s forecasting challenge.
By the way, the prize for the winner - a one year subscription to Barron’s and lunch in Manhattan with the magazine’s editor.
