Expectations vs. Forecasts

By Markets Fool.com

I expect there to be one or two recessions in the next decade. I have no idea when either will arrive.

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Those aren't contradictory statements. One is an expectation, the other is the rejection of a forecast. It's an important difference.

It's one thing to look at history and see that recessions and bear markets have occurred with some frequency, and forming a baseline of what to expect in the future. It is quite another to predict the precise timing of either event. And it's another thing entirely to devise a strategy that reacts to those predictions.

Analysis isn't black and white, where some people believe we can predict markets and everyone else surrenders with their hands up. There's an important gray area, which is expecting certain events to occur without having an opinion on when, where, why, or how.

There have been 12 recessions since the end of World War II, or an average of about two per decade. You can use this as a very rough rule of thumb for the future, based on the idea that we'll screw up and plow ahead about as regularly as past generations.

Now I have an expectation: If I plan on investing for the next 30 years, I should count on things getting ugly at least six times. Maybe it'll be a little more, maybe less. But I have an expectation, a rough idea of how the game works.

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But it's not a forecast. A forecast is, "We will enter a recession in the first half of 2018." That's precision, with a disregard for both the history of people making such forecasts and the events that cause recessions which, a lot of the time, is something that can't be foreseen.

The important difference between an expectation and a forecast is the impact it has on behavior. If I expect recessions and bear markets, I won't be surprised when they come. I know they're a normal part of the game. But since I'm not sure when they will come, I won't attempt to do much about it. Attempting to do something about it trading, timing, buying and selling is the root of most investors' misery and mistake in the first place.

You don't get that humility safety net with a forecast. A forecast offers the idea that you know when something will happen, which is permission to act on it. There's little reason for a forecast other than acting on it, in fact. This creates a two-for-one problem: The false hope of knowing when a bear market will come and the high-probability of regret from trading around it.

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Contact Morgan Housel at mhousel@fool.com. The Motley Fool has a disclosure policy.