I ran across a classic 1993 piece from Financial Analysts Journal today on the subject of consensus, forecasting and investment returns, and it has some points worth repeating. Let’s start with the following:
Everyone’s forecasts, taken together, form the consensus forecast. If your prediction is consensus too, it won’t produce above-average performance even if it’s right [emphasis added]. Superior performance comes from accurate nonconsensus forecasts. Because most forecasters aren’t terrible, actual results fall near the consensus most of the time — and nonconsensus forecasts are usually wrong.
These are, arguably, among the most useful insights you can get on being a successful investor, whether in public or private equity. There are three underlying points:
-
The consensus is the collected “wisdom” of market participants
-
Bucking the consensus is the way to make real money
-
But the consensus is usually right, so bucking it rarely works
This is so important. Because most people not only don’t get past consensus-thinking, they don’t even really know what the consensus is. Put another way, they haven’t figure out yet that the only thing that matters in earnings estimates is the divergence from analyst consensus. More broadly, they have no idea where to begin figuring out which one or two things they currently believe is least likely to hold up in the future. Low interest rates? The centrality of CDMA? The U.S.’s hegemony? $60 oil prices? The current allocation of venture capital to information technology companies? And on and on.
But there is a second-order problem. Having figured out that they need to be nonconsensus thinkers, most people aren’t equipped to figure out where the consensus is actually actionably incorrect. It isn’t enough, of course, for the consensus to be wrong in some way; it has to be wrong in a specific way that you can a) identify, and b) usefully act upon. Which brings us to a second quote from Howard Marks’ FAJ 1993 piece:
…being too far ahead of your time is indistinguishable from being wrong.”
Great stuff.
Related posts:
What a bunch of bull!!
or… What a load of common sense.
Joe — Why do you say that?
P.
It is quite clear there is no money in consensus. Your sustainable competitive advantage in investments is poking profit making holes in to consensus views for arbitrage.
Love your last quote from Howard Marks. Almost personal.
-v
PS: Yeah Joe I too wanna know why you say what you said?
I agree with the point that it might only be common sense.
Althought pretty cool to read, It isn’t full of much knowledge that you can exploit…
…unless you lack common sense that is.
Perhaps we are all Keynesians now:
“Successful investing is anticipating the anticipations of others.”
-Motts
Paul…any chance of a link to this 1993 FAJ piece…? Interestingly, there has been a fair bit of research that shows betting against “guru’ market forecasts, i.e. sentiment bell curves, can be fairly rewarding. I believe you have mentioned Ken Fisher’s use of this previously on RealMoney.com.
What would TiVo do?
WWTD: They would soon rollout the video-on-demand service we all know they’ve had in the works for a while now….
I’m sorry if I offended anybody.
…I just couldn’t hold it.
One question I have for you guys:
do you guys do any trading, or do you just like to talk about it?
Another question:
Can anybody describe an scenario to trade tomorrows oil price, next weeks, next months?
Thanks in advance.
BTW, try to apply your “consensus insights” to your scenarios.
Contrary to Joe, I think this is actually dead on, although the first part reads a bit like the old efficient-market theory, i.e. stock prices must be efficient because all current information gets priced in immediately (duh). Furthermore, what qualifies as a superior investment return? Being down 9% when the S&P is down 10%? I would argue otherwise, that it should be defined as steady positive returns in most environments, with the chance for outsized returns in times of crisis or panic.
The best part is the quotation at the end from Marks (very topical for me personally, as this problem seems to continually plague me on the short side, usually forcing the question of how dogged to be when a short with great fundamentals is being run up in one’s face? See FLM, WIN, PRD, etc. Always better to be profitable than eventually right).
The point that outperformance is driven by accurate away-from-consensus forecasting is true, but what does that truly mean? I would argue that most would interpret that statement as one’s ability to predict whether a company meets, beats, or misses EPS estimates for a given quarter, which misses the greater point. One must focus more on where the balance sheet is going to be several quarters from now, more on macro issues like valuation and the credit cycle than on companies meeting or beating a given quarter’s consensus EPS. Who cares where the oil price is next week or month? I care where it will be two years from now.
Frankly, Post-Reg FD, the value placed on meeting/beating street quarterly EPS estimates, which in most cases are just copied straight from company-provided estimates, and/or whisper estimates has become laughable. Strong cash flow results in a case where EPS misses and a stock plunges is often a great time to buy. In my view, the best way to invest on the long side — and particularly on the short side — has little to do with quarterly analyst consensus. Shorting companies that one expects to miss a quarter but don’t have a credit hammer is a fool’s game. Free cash flow yield and improvement/decline therein are often unrelated to EPS.
I would argue that most people’s investing is primarily emotionally driven. Small investors and mutual funds alike tend to buy most heavily after a few years of a rising market, when they feel comfortable looking backwards at an environment that appears low-risk. The real value in investing lies in having the skills and composure to pick up (or short) the gifts that others puke out (or drive up) during panicked (or euphoric) times. That ability probably stands out as the biggest potential non-consensus call of them all.
Joe, since you are asking, I have 10 yrs HF experience to back this up.
PC
In fewer words, “the public is usually wrong”, could mean the same thing.
Or it may be saying: study your trade hard, do not be a mediocre –consensus guy ?
OK, my point is, with this information, we know the mine is somewhere out there in the desert. It doesn’t really put a nugget of gold in my hand, does it?
Paul c, since you don’t care about oil, would you mind teaching me a lesson of how you trade, take your pick, applying your 10 year HF experience.
I must admit, in my ignorance, HF escapes my vocabulary.
Thx in advance.
Joe,
HF = hedge fund.
I do think the public is usually wrong — insofar as you mean small investors participating in the stock market, real estate investing, etc. They tend to worry most about keeping up with the Joneses, so end up buying high and selling low.
In my experience, outperformance in stock investing seems to come from bucking general sentiment — buy stocks of despised companies that aren’t going bankrupt. Or in more general terms (an old industry truism) — when you hear housewives talking about the stock market, head for the hills.
I make no claim to know more than the next guy about stock-picking, but since you appear to be a non-financial professional seeking strategy advice, I would say:
(a) invest rather than trade — excessive trading typically just makes money for your broker. Plus how are you going to be quicker/more ahead of the curve than some guy in NYC with 50 computer screens and a staff of 50?
(b) don’t try to pick individual stocks unless they’re in an industry you work in (i.e. if you’re not in the oil or tech business, if you’re looking to invest in oil or tech, expect that you’ll be the slowest car at the Indy 500).
(c) focus on big market moves — buy at times when people are moaning about how bad things are (mid ’02 to mid ’03), get out when everyone is talking about how great they’re doing (1999).
Keep fees down at every opportunity (use index funds, UST direct)
Find a true uncorrelated product (I read in the WSJ the other day that Schwab offers a long-short mutual fund for something like a $2500 minimum investment. This fund is up 7% this year – pretty good given the climate).
Avoid standard mutual funds at all costs.
Get the most out of your cash (ING Direct is good).
P
PC,
I appreciate the info and the effort.
Good trading.