Why We Listen To Bad Forecasts

London had 120,000 residents in 1523.

A fifth of them – 25,000 people – had fled the city by February 1524.

They weren’t running from war or famine.

In the summer of 1523 a group of fortune tellers warned that on February 1, 1524, the River Thames would swell so high it’d swallow London whole. It was met with widespread belief. People panicked.

Some Londoners took shelter in tents a few miles from the city. Others assumed that wasn’t enough. “In January, droves of workmen might be seen, followed by their wives and children, trudging on foot to the villages within fifteen or twenty miles, to await the catastrophe,” Charles Mackay wrote.

The tide, by all accounts, was normal on February 1st.

How does this stuff happen? Why do people believe far-fetched forecasts with no track record of accuracy? Especially a fifth of the population of a major city, not just a few quacks?

You have to remember that life was miserable and unpredictable back then.

Famine and disease led to wretched lives for virtually everyone in 1523. Life expectancy was 32 years in 16th century Europe, driven by child mortality whose tragedy was leveraged by ignorance of its causes. Germs weren’t discovered for another 300 years. So just making it through the day was a high-stakes, confusing, gamble. And when you mix high stakes with uncertainty, the more likely people are to heed wild predictions of danger, just in case. Part desperation, part proper risk management.

A century later, as London was gripped by plague, the fortune tellers yielded more power than ever. Mackay again:

During the great plague of London, in 1665, the people listened with avidity to the predictions of quacks and fanatics. Defoe says, that at that time the people were more addicted to prophecies and astronomical conjurations, dreams, and old wives’ tales than ever they were before or since. Almanacs, and their predictions, frightened them terribly.

The correlation between high stakes and people’s willingness to believe quackery is high. And it’s pretty rational.

A low-probability, high-stakes prediction should always be taken seriously. And if your world is so confusing that you can’t determine probabilities, defaulting to assume that prediction will come true may increase your chances of survival.

When things are calm people believe what they tell themselves. When things are crazy they believe what other people tell them.

That’s why we listened to bad forecasts 500 years ago. And why we listen to bad forecasts today.

The history of financial forecasts is long. And it is pathetic.

Twenty-two chief market strategists at major banks predict the S&P 500’s annual performance at the start of every year. The average difference between their forecast and what the market actually does is 14.7 percentage points per year. If, instead, you blindly assume the S&P 500 goes up by its historic average every year, the error is lower – 14.1 percentage points.

The history of predicting recessions and interest rates and economic growth is just as bad.

So why is there still rabid demand for forecasts?

It’s not as simple as “hope” or “ignorance” or “bias” – although there’s truth to each.

People listen to financial forecasts because:

If economies confuse you – and if they don’t you’re not paying attention – and someone says “I can earn you a fortune if you listen to me and if you don’t you will lose a fortune,” the temptation to listen is huge. The stakes are so high that it can be dangerous to not listen to forecasts, despite their track record – just in case.

This is especially true when you’re surrounded by huge amount of economic loss and gain.

The 2008 financial crisis created diehard followings to those predicting hyperinflation and collapse. This was a front-page story in the Wall Street Journal in 2008:

[A professor] posits, in brief, that mass immigration, economic decline, and moral degradation will trigger a civil war next fall and the collapse of the dollar. Around the end of June 2010, or early July, he says, the U.S. will break into six pieces – with Alaska reverting to Russian control.

Last year brought equal faith and attention to those making the wildest cryptocurrency predictions.

In each case the stakes of loss or gain were huge. Fortunes could be made or lost – lives ruined or transformed. Layer in a world that was wildly confusing – banks collapsing, unprecedented monetary policy, digital currencies suddenly worth hundreds of billions – and people hearing these forecasts have no base rate of past accuracy to judge against. When nothing makes sense, any prediction seems as likely as another. So people take the wild ones seriously, just in case. The financial version of Pascal’s Wager.

It’s like playing Russian Roulette without knowing whether the gun has three chambers or a billion chambers. If the stakes are high and you have no idea what the odds are, you pay attention.

That’s not an excuse for heeding bad forecasts. We know enough about the types of people who make wild investing forecasts and their incentives to safely discount a big portion of babble. But it’s an explanation for why people do it.

Brent Beshore has a great philosophy: “In the moment, people act rationally, always,” he says. “The question is what information, preferences, time horizon, and biases came into play?” High stakes and uncertainty is a huge information asymmetry that causes rational people to pay attention to crazy forecasts.