How to Know When a Talking Head Is Full of Hot Air

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I like explaining things through headlines. A few summarizing words is often all you need to tell a long story.

For example, you can sum up the madness of investor psychology with these two headlines of expert forecasts, both heavily plugged during their respective times:

October, 1999: "Analysts Say Dow Will Rise Up to 36,000"                         

June, 2010: "[Analyst] Says Dow Could Fall to 1,000"                                          

Mind the gap
Staggering. In 11 years flat, the most hyped-up and oft-cited market forecast collapsed by 36-fold. Yet what changed during those 11 years? In 1999, GDP was $9.3 trillion; today, it's well more than $14 trillion. In 1999, the S&P 500 earned $51.68 per share; this year, it's on track to earn $82.

Rationally, none of this makes any sense, until you remember what else changed in the past 11 years: Average investors were drunk with optimism in 1999, and they are equally smashed with fear today. Bullheaded expert forecasts like the two above help explain why.

That isn't a profound insight, I'm aware. But the way expert opinions influence investor psychology suddenly has a new meaning to me.                                                                          

I just finished the book Expert Political Judgment, by U.C. Berkeley professor Philip Tetlock. This isn't a new book -- it was published four years ago -- but its findings are probably more relevant today than they've ever been.

Twenty-five years ago, Tetlock began compiling a database of expert forecasts, hoping to find out who was capable of making good predictions, and why. Here's what he found:  

1. As a group, expert forecasters are horrendously bad at what they do, rarely beating the predictions of a "dart-throwing chimp."  

2. Experts can get away with lousy predictions, because the media doesn't offer an objective scorecard on past calls. "If it were easy to set standards for judging judgment that would be honored across the opinion spectrum and not glibly dismissed as another sneaky effort to seize the high ground for a favorite cause, someone would have patented the process long ago," writes Tetlock. People still ogle when Abby Joseph Cohen makes a bullish call, permabull status and past performance be damned. Why? Because she works for Goldman Sachs (NYSE: GS  ) , and her past calls have faded into distant, painful, memory. 

3. There's very little correlation between experience and accuracy. Someone who's been in the business for 50 years isn't statistically much better than a rookie. "As expertise rises, confidence in forecasts should rise faster than the accuracy of the forecast, producing substantial overconfidence," Tetlock notes.  

4. There's a negative correlation between experts' popularity (measured by media appearances), and accuracy. The more popular they are, the less accurate their predictions become. Chalk that up to hubris. "The more frequently experts are asked to offer their opinions on current events to the media, business, or government," Tetlock explains, "the greater the temptation to offer quotable quotes and good sound bites."

5. People who trumpet one extremely bold, all-encompassing theory and stay glued to their foundation are painfully inaccurate. Tetlock calls them hedgehogs. Those who make many small predictions and constantly update their outlook based on new information have a pretty good track record. He calls them foxes.

That last one is the most important. In a 2009 interview, Tetlock explained how investors can differentiate between hedgehogs and foxes:

Count how often they press the brakes on trains of thought. Foxes often qualify their arguments with "however" and "perhaps," while hedgehogs build up momentum with "moreover" and "all the more so." Foxes are not as entertaining as hedgehogs. But enduring a little tedium is worth it if you want realistic odds on possible futures.

This makes a lot of sense. Those who stay flexible and realize the world is dynamic are better judges than those who pretend it's built on certainties.

What's sad is that today's world is knee-deep in hedgehogs, and we pay scarce attention to the foxes. There are foxes out there right now making predictions that have a high probability of coming true -- the blog Calculated Risk comes to mind. Unfortunately, the media buries their voices in obscurity. They speak too softly. They're too dull. Too logical. Instead, we get Jim Cramer on live TV five days a week, with an occasional smattering of Lenny Dykstra bonus calls.

You know the other obvious hedgehogs: Those who dismiss anything less than gold at $5,000 an ounce as drivel; those who claim Sirius XM (Nasdaq: SIRI  ) is the greatest breakthrough since penicillin; those who extrapolate current conditions into infinity to conclude that the U.S. will never recover from recession. Peter Schiff. David Lereah. Nouriel Roubini. Harry Dent. Robert Prechter (father of the Dow 1,000 prediction). These are classic hedgehogs whose views rarely change, and whose popularity explodes when the broken-clock-is-right-once-a-day rule works in their favor. They're the types of talking heads Tetlock's data suggests you ignore.  

Pardon the maniacs
As for Dow 1,000? Most of us have forgotten that Robert Prechter was calling for Dow 777 (no zeros emitted) in 2002 as well. Once again, we've done a poor job keeping score.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.   

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (11) | Recommend This Article (32)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 13, 2010, at 12:35 PM, tfirst wrote:

    You mean...SIRIUS isn't the greatest thing since penicillin?????

  • Report this Comment On July 13, 2010, at 12:59 PM, pwhitten wrote:

    I don't understand why so many people are anti-Cramer, as his mission is the same as TMF - to educate, amuse, and make you money. Anyone who watches him on a regular basis knows that he ALWAYS recommends Buy & Homework. I would never buy a stock just because he says it's a buy-buy-buy. I buy stocks because he recommends them, and because I have personally checked them out to see if they are suitable for my portfolio.

    What I really like about Mad Money is his commentaries on the market as a whole, and I like how he explains the reasons behind the direction of the market. He also stresses sector analysis, while a lot of other investment gurus seem to pay it lip service.

    As for Glenn Beck, I do not look to him for investment advice, he's definitely a political commentator. He is very passionate about what he believes in, and he ALWAYS has facts to back up what he says.

  • Report this Comment On July 13, 2010, at 1:09 PM, cmfhousel wrote:

    Alright, pwhitten. Fair point about Beck. He is a political commentator (although that was the basis of Tetlock's book). Keeping this article on the financial side, we'll yank the Beck reference out of taste.

  • Report this Comment On July 13, 2010, at 8:50 PM, ChrisBern wrote:

    I suspect Cramer is a pretty good investor on his own accord. But anyone who listens to the shotgun-approach buy or sell calls he makes has to realize he's just shooting from the hip on most of that. When you're covering hundreds of companies like he is on his show, there's no ability to dive deep enough on any one of them to analyze whether or not it's a sound investment. The only exception to this rule I can think of was Peter Lynch, who was able to do just that.

  • Report this Comment On July 14, 2010, at 10:41 AM, loosestreet wrote:



  • Report this Comment On July 14, 2010, at 11:53 AM, AjarnMichael wrote:

    It seems to me there is a lot of money to be made by any group who starts documenting expert predictions into a database and then analyzed this information and wrote an ongoing column. Basically the type of information that professor Tetlock did. Does anyone know of one that is kept and made public? I'll certainly be checking out professor Tetlock's book, but would be more interested in reading occasional articles about the analysis of this database.

  • Report this Comment On July 15, 2010, at 7:08 AM, RagnarRedbeard wrote:

    How to know when a talking head is full of hot air?

    Are his lips moving?

  • Report this Comment On July 15, 2010, at 11:21 AM, slpmn wrote:

    More interesting than the opinion of experts is the opinion of non experts. The book "The Wisdom of Crowds" provides some excellent food for thought. Poll a large, diverse group of people on any given topic, and its likely their collective reponse will be more accurate than the prediction of an expert in the field. One of the best examples of this phenomenon is the "ask the audience" option on Who Wants to Be a Millionaire. It's hard to think of a more random group of shmucks than a television studio audience, but more often than not, as a group, they indicate the correct answer.

  • Report this Comment On July 15, 2010, at 11:32 AM, noryakerson wrote:

    Great article.

  • Report this Comment On July 15, 2010, at 5:01 PM, PeyDaFool wrote:

    Here's an article from the New York Times about Pretcher and his predictions for the future. It's called "A Market Forecast That Says ‘Take Cover.’"

    Seems a bit like a doomsday scenario...

  • Report this Comment On July 16, 2010, at 12:50 PM, Knightmare535 wrote:

    My personal favorite is anything followed by "current volatile market conditions." In the 15-20 years that I've been following the investing world, I do not ever recall hearing "the current calm and tranquil conditions."

    BTW, in reference to your second to last paragraph, most broken clocks I've had were right TWICE a day. Good article!

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