Article by Benedicte Gravrand, Opalesque Geneva, 13 February 2015
Nowcasting is to forecasting what astronomy is to astrology
Alexander Ineichen, founder of Ineichen Research and Management, an independent research firm based near Zurich, recently produced an interesting risk management research piece on forecasting and nowcasting (called Nowcasting and Financial Wizardry). In this piece, he displays, with examples and statistics, the imprecision of forecasting and the logic of nowcasting for decision making in finance.
The piece is also entertaining because he recalls quite a few past predictions made famous for their sheer inaccuracy, such as "The horse is here to stay, but the automobile is only a novelty – a fad," or "There is a world market for maybe five computers," or even, "The bomb will never go off." Within finance, a similar number of goofy predictions have been made, much to the subsequent embarrassment of the forecasters - most of whom, Ineichen notes, well educated and confident individuals.
"Dozens of studies discrediting experts have made it clear that expert failure extends far beyond the investment scene," he writes. "And the problems often reside in man’s information processing capabilities.
"Current work indicates that the expert is a serial or sequential processor of data who can handle information reliably in a linear manner – that is, he can move from one point to the next in a logical sequence. However, a solution to a complex problem can require configural (or interactive) reasoning. In a configural problem, the forecaster’s interpretation of any single piece of information changes depending on how he evaluates many other inputs. The configural relationships of a company or the market place itself are extremely complex. In addition, research in configural processing has shown that experts can not only analyse information incorrectly, they can also find relationships that are not there – a phenomenon called illusionary correlation."
As for intuitive judgment, he says, it suffers from serious random inconsistencies due to human biases and heuristics. And if you compare an expert’s intuitive prediction, a subjective model and an objective model, studies find the objective model is always more likely to get it right.
When there is volatility and uncertainty, one may wish to fall back on an expert’s view. The alternative to an expert’s view, he says, is the view of a non-expert or a fortuneteller. But there is a further alternative to that, namely nowcasting.
Experts are worth their salt for their experience, knowledge and insight, he adds. But in the end, a forecast is biased because it is an opinion. And an investment process based on facts rather than opinions seems more logical.
Nowcasting is a new word and a contraction of "now" and "forecasting." It is used in meteorology and economics. In the former, it is "the detailed description of the current weather along with forecasts obtained by extrapolation up to about two hours ahead." In the former, it is standard measures used to assess the state of an economy (as for example, the GDP), based on facts, determined after long research and subject to revisions.
According to Ineichen, "a nowcaster does not try to predict the future but focuses on what is known today, i.e., known now in real time. Many investors are hooked on forecasts. Forecasts are an integral part of orthodox asset allocation and are essentially guesswork. In other words, guessing is an integral part of how assets are allocated and risk is taken. However, when I listen to for example trend-followers, it seems to me that many of them do very well without a forecast entering their investment approach. Trend followers look at prices, not forecasts. A price is a fact, whereas a forecast is not…" A trend is simply either positive or negative, he continues.
He examines three types of momentum for nowcasting (price, economics and earnings) in the rest of the report – which you can obtain by contacting him.