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 (NAS: GMCR) back in October 2011 and another on Chipotle (NYS: 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.

The article Why Financial Pundits Should Be Afraid of Nate Silver originally appeared on Fool.com.

John Reeves owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Chipotle Mexican Grill and Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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