Why Financial Pundits Should Be Afraid of Nate Silver

On the Monday before the recent presidential election, Peggy Noonan, a columnist for The Wall Street Journal, had a premonition. Despite all of the tiresome polls that seemed to point to a clear victory for President Obama, she believed the Republican challenger Mitt Romney was going to win. "All the vibrations are right," she felt, for a Romney triumph.

We now know, of course, that all of those pesky polls, when considered in aggregate, were fairly accurate. President Obama ultimately secured 332 electoral votes -- 62 more than was necessary to win. Somehow, Noonan's "vibrations" had been sending the wrong signal.

Just three days after the election, Noonan bravely acknowledged the Obama victory, and then provided some advice to her fellow Republicans. It's perfectly fine, of course, to offer advice and make predictions, but one wonders why anyone would value the opinions of someone who got the election so wrong.

New rules for financial pundits
Nate Silver is one observer who didn't get it wrong. His model successfully predicted the presidential winner in all 50 states. Despite that remarkable performance, he told the comedian Stephen Colbert that his methodology is quite simple, even though people "treat it like Galileo, something heretical."

His model took an average of the polls, and then calculated the probabilities of victory for each candidate. Unlike many of the pundits, he was willing to put money behind his predictions as well. For Silver, it shows "you have integrity" if you put money behind an idea.

At the Motley Fool, we couldn't agree more about the need for some form of accountability for pundits in all fields. The woeful performance of the political pundits during this recent campaign highlights the potential dangers of unaccountable pundits and analysts in the financial world as well. Fool co-founder David Gardner passionately believes that we must insist on everyday accountability -- whether it's on a stock pick or a market call -- from our financial media. In a recent conversation, David told me that there will always be a plentiful supply of financial predictions, but that readers must know which ones to value, and which ones to ignore.

Losing money isn't entertaining
Most of us know, of course, that political punditry is primarily a form of entertainment. Nate Silver, in his new book The Signal and the Noise, has actually taken a close look at all of the predictions from the popular show The McLaughlin Group, and found that they "may as well have been flipping coins."

What might seem like harmless fun in the political realm can be extremely costly in the financial space. When Jim Cramer predicted that Obama would get 440 electoral votes in the recent election -- a scenario that would have required Obama carrying traditionally "red" Texas and Georgia -- we can all just laugh it off as egregious self-promotion. If Cramer predicts a stock will double, however, but it goes down by 40%, then that might have serious consequences for investors who follow that advice.

Beware of the parabolic spike
My colleague Jim Mueller recently discovered an excellent example of wayward financial punditry. In late August 2012, Nomura strategist Bob Janjuah declared that we were entering a serious "risk-off" phase until November 2012. During the period from August to November, Janjuah predicted the S&P 500 (INDEX: ^GSPC  ) would "trade off down from around 1400 ... by 20 to 25 percent ... to trade at or below the lows of 2011."

Of course, we now know that the S&P 500 was only down 2.7% during that time (through the close on Nov. 13). So far, Janjuah is only off by 20 percentage points or so. Just yesterday, he weighed in again with the following call:

"If I look out 3-6 months I am open to the idea of one last parabolic spike higher in risk-on markets in this interim timeframe."

Based on his earlier prediction, investors might be wise to be wary of Janjuah's crystal ball. One way or another, investors would need to know his track record before putting money behind his forecasts.

What's this analyst's batting average?
David Gardner dreams of a day when every financial source tracks itself publicly and transparently. He told me that he'd love to see every pundit or analyst have their own publicly available track record that could be easily called up on our screens. In an era of second screens -- that's the new term for looking at your iPad or other device while watching television -- you'd be able to bring up someone's track record just as they begin offering up their prediction on CNBC or some other network. David feels this would save people from wasting their time and money on poor predictions. It would also make the financial media smarter and more discriminating.

Going forward, we encourage consumers of financial media to insist that pundits share their track records and revisit their forecasts and stock picks. Readers should also look for sound reasoning based on evidence as opposed to dubious conclusions based on a gut feeling. At The Motley Fool, we've been asking all of our writers and analysts to make a CAPScall whenever they take a strong stand on a particular stock. That way, we make a public record of our stands on particular stock recommendations.

My colleague Rick Munarriz recently provided a great illustration of how accountability should work for financial analysts. After earlier challenging two short calls by David Einhorn -- one on Green Mountain Coffee Roasters (Nasdaq: GMCR  ) back in October 2011 and another on Chipotle (NYSE: CMG  ) in October 2012 -- Rick wrote a follow-up piece admitting that Einhorn had been right, and that he had been wrong. By doing this, Rick avoided the temptation to quietly move on to another call. As a result, we are all smarter about these two companies.

So far, we've made approximately 250 CAPScalls per month since the beginning of 2012. And we've also been keeping track of all of our real-money stock picks on Fool.com.

Good vibrations
As for me, readers can view the performance of my real-money stock picks by visiting our portfolio homepage. It's been a tough run for growth stocks, and some of our picks are down a lot so far. Frankly, I don't always find it easy to have the track record out there so publicly. All things considered, though, it's far better for our followers and more fun for us to keep score. This is especially true since a drive-by stock recommendation without any accountability behind it would result in some seriously "bad vibrations" for everyone.

Read our entire "Moneyballing the Financial World" series here:

And if you'd like to learn more about Green Mountain's risks and opportunities, check out our new premium research report. In it you'll find everything you need to know about the company, including whether our analyst thinks it's a buy at today's prices. Click here for instant access.


Read/Post Comments (16) | Recommend This Article (59)

Comments from our Foolish Readers

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 November 15, 2012, at 1:27 PM, TMFGebinr wrote:

    Of course, if CNBC et al. published the prediction track records of their pundits / experts, they'd have to find somebody else pretty quickly or figure out something else to air or publish. But they won't because we crave the voice of authority making a prediction -- and we'll all be losers thereby.

    To put it bluntly, humans absolutely suck at making predictions. And the more "expert" one is in a particular field, the worse the performance is. I remember one experiment that showed average college students outperformed investment experts at predicting what stocks would go up. Another study looked at lots of political predictions over the decades and showed that the political experts did worse than what flipping a coin would predict.

    I agree with your thesis, John. If somebody tells you that something is going to happen, find out how good they are at making predictions before doing anything based upon that prediction.

    Thanks for including me in your article.

    Jim

  • Report this Comment On November 15, 2012, at 2:22 PM, TMFSpiffyPop wrote:

    John, well conceived and well written. Thank you for pointing investors' focus to a much bigger and more consequential market -- our financial markets -- than the political predictions market. Cleaning THIS market up -- creating more transparency and accountability around financial predictions -- will be very valuable. And not just every four years.

    --David Gardner

  • Report this Comment On November 15, 2012, at 6:14 PM, vfsimmon wrote:

    The Motley Fool has predicted a big, maybe Giant quarter, for Apple. Seeking Alpha has claimed that shrinking margins and supply chain constraints will hurt earnings. As TMF has pointed out, AAPL has made a significant commitment to components that will end up in product sales this quarter. I don't know which analyst is right, but if it were an election, I know who I would be voting for.

    Long AAPL

  • Report this Comment On November 15, 2012, at 11:20 PM, Rolfmeister wrote:

    Well that sounds nice, but all the major polling sites had the race too close to call and at least she wasn't feeling a tickle up her leg. And regardless, who gives a crap? Every financial newsletter I get has their brainless wizards making the same claims three years after they made one hundred similar predictions and then cherry picking the two that came true claiming that if you hadn't sat on the sideline and had only listened to Gandalf you too would have realized a 3000 percent gain. Sure you put up your money on all these predictions and sat on them all for 3 years. Believe that and I have some swamp land I'd like to sell you. Your lame attempt to make a political point in a financial newsletter has me looking elsewhere for financial advice. Have you ever thought of working at the NY Times?

  • Report this Comment On November 15, 2012, at 11:43 PM, chopchop0 wrote:

    I was pretty impressed with Einhorn on GMCR and CMG. Then you have to realize that he's been long AAPL through 700 and the subsequent carnage since

  • Report this Comment On November 16, 2012, at 7:04 AM, JadedFoolalex wrote:

    William Bernstein, in his book "The Four Pillars of Investing", wrote about a study which was conducted to show how fund managers did in predicting which stocks would do well over the course of a year. Their competition was a group of monkeys throwing darts at names of the stocks on the New York stock exchange. The monkeys picked as many winners as the best fund managers with all their high powered research departments and other state of the art tools!! So, remind me again as to why I should listen to any so-called expert making predictions about stocks???

    Do your own research, make intelligent and reasoned decisions about buying great companies with reasonably guarenteed lives and hold them for a very long time! You'll do far better than any "expert" ever will for you.

  • Report this Comment On November 16, 2012, at 8:23 AM, Briman63 wrote:

    I would love to see a scoring system for pundits -- both financial and political. As they make a prediction on a topic, there should be a graphic at the bottom of the screen, scoring them on accuracy of past results. Financial evaluation should be required, political would be interesting, but harder to calculate. Let's let Nate Silver propose a tracking formula, he's obviously has a good tracking system. (Rolfmeister totally missed that point, the polls were NOT too close to call, when you analyzed the data as Nate did.)

  • Report this Comment On November 16, 2012, at 10:49 AM, moneymog wrote:

    CERS and COTE long, the predictors cited above and the Motley Fool is junk science. Their science and mechanics (respectively) is real, superb and highly investment worthy..... been a long long time since being anywhere on your site.

  • Report this Comment On November 16, 2012, at 11:44 AM, topbeancounter wrote:

    After interviewing the now former head of GE, Maria bravely announced that the interview had apparently been a lie, since she knew why he left and freely offered her OPINION, only later to be dead WRONG. I thought these folks were talking heads REPORTING the news, not their opinions.

    As an Independent, I found it more and more difficult to listen to Joe and Rick in their morning comments leading up to the election. REPORT THE NEWS. I actually began listening to the fair-and-balanced news channel since I knew I would get very little news and a lot of right-wing opinion. They didn't even pretend to be telling the news, only their opinions.

    I stopped listening to the McLaughlin Group years ago after doing a bit of my own math and found the coin flipping suggestion to be rather sound. He needs to retire....soon.

    Yes, many of these clowns should be very afraid of Nate. That young man has about figured it all out.

  • Report this Comment On November 17, 2012, at 5:00 PM, secjd wrote:

    @Briman63 - Actually, there is - whenever I get notifications from Ameritrade about changes in the ratings of stocks I own, they show the percentage of the time when their analysts have been right about their ratings/predictions for that particular stock- and it is usually less than half of the time...

  • Report this Comment On November 17, 2012, at 5:17 PM, secjd wrote:

    MF should tell all this to the people at Newsmax - who are perenially predicting disaster (LOL). Unfortunately, the "news" media cares more about their Nielson ratings than anything else and, even more unfortunately (as most of us know), what seems to get them high Nielson ratings is:

    1. Sensationalism;

    2. "Talk radio" - type propaganda that is aimed at people's emotions and affirms whatever particular viewpoints they already hold; and

    3. Especially in the financial arena, predictions of "doom and gloom" ("Watch our show tonight - your life just might depend on it!")

    So, instead of repeatedly making the same observations and complaints (valid though they are), maybe we should be asking ourselves why it is that such garbage is what earns the high ratings and what (if anything) can be done to change that.

  • Report this Comment On November 19, 2012, at 10:28 AM, Chontichajim wrote:

    Nate Silver did not make a "prediction" on the elections, he just followed polling data without introducing any political bias. Nothing like these meaningful polls exist in markets.

  • Report this Comment On November 19, 2012, at 12:29 PM, ourporch wrote:

    Could not find the correlation between Nate Silver's political math and why financial pundits should be afraid of him. Nice article but he did nothing financial, so what's your point?

  • Report this Comment On November 19, 2012, at 12:34 PM, ourporch wrote:

    Follow up to my first comment. You need to be more specific for me to get your point. What is the key takeaway for investors? If you make a statement like that please tell me what you mean and not make me figure it out.

  • Report this Comment On November 19, 2012, at 12:44 PM, TMFBane wrote:

    @ourporch, That's a fair question.

    For me, Nate Silver's activities were instructive on two levels.

    First, his predictions were based on evidence. He used a wide variety of state and national polls, and was fully transparent about the changing probabilities for his predictions. Just the fact that he thought in probabilities is very instructive for investors, I think. So, on the one hand, we had some political pundits out there who didn't do any work, and instead were saying stuff like, "my gut tells me this or that..." And they were often quite sure of themselves too. Silver warns that we can't predict the future -- that's why probabilities are helpful.

    Second, Silver shares of all of his thoughts publicly, and is willing to put money behind his predictions. In other words, he's accountable. There are just too many political pundits who make the boldest claims based on the fluffiest of evidence, and then they just say, "oh, well" when their predictions don't work out. I feel Silver put himself on the line during this election, and I'm sure he'd have subjected his model to a critical analysis if he had been wrong.

    Given all that, we felt that Silver's approach is something financial pundits could learn from (I, of course, recognize that there are subtle differences between political and financial punditry).

    Financial pundits should base their views on evidence; they should back up their opinions; and they should hold themselves (or be held!) accountable after the fact.

    Finally, we're beginning to see a pretty nice track record for Silver's model too. We'd like to see track records for financial pundits as well.

    Anyway, just some quick thoughts -- sorry, if I rambled too much here!

  • Report this Comment On November 19, 2012, at 1:41 PM, ourporch wrote:

    Thank you, thank you, thank you. Your third paragraph from the end summarizes what I needed and the rest elaborates your points nicely. And, I agree wholeheartedly.

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