The perils of insouciance

Jonathan Davis says investors’ disregard for risk has paid off handsomely in 2006 — but it may not in 2007

A good general rule for investors is to take no notice of consensus predictions about what is going to happen in the next 12 months. The track record of year-end investment punditry is consistently poor. That makes the Christmas and New Year period particularly hazardous for the unwary investor, as the demand for forecasts is at its peak, and the capacity for misdirection consequently also high.

This is especially so for those who are not aware of J.K. Galbraith’s adage that economists forecast ‘not because they know, but because they are asked’. One professional investor of my acquaintance has turned forecasting folly into a source of insight. Ken Fisher, an investment manager from the West Coast of the United States, logs the market and interest-rate predictions of all the mainstream market forecasters in the US, who are legion. His own forecast is then based on the simple premise that the actual out-turn in any given year, whether for interest rates or stock markets, will not fall into any of the bands that more than one expert expects. So far his results have been remarkably successful. Most of the time, he finds, most forecasters cannot even get the direction of the stock market right, let alone the scale of the change.

As the City’s pontificators are still working on their predictions for 2007, it’s too early to tell in which wrong direction this year’s end-of-year consensus will go, but looking back on the investment story of 2006 will make pleasant reading for most investors. Despite dire warnings about the likely impact of higher interest rates and the collapse of US house prices, 2006 looks like ending as a year in which insouciance, or disregard for risk, has again paid off handsomely.