I really thought pigs would fly before I would agree with UBS on any investing issue.

A Deplorable Record

To be fair, UBS is no better or worse than most brokerage firms. Nevertheless, its corporate rap sheet is replete with appalling conduct, including conflicts of interest between its research and investment banking activities, cheating mutual fund customers, violating U.S. trade sanctions, market timing violations, various charges relating to its role in financing Parmalat, an Italian dairy company that collapsed in 2003, and many others. More recently, it paid $445 million to the National Credit Union Administration to resolve claims by two credit unions that they had been sold “toxic securities.”

While this deplorable record should be enough to dissuade investors, it’s relatively minor compared to the core reason why you shouldn’t rely on any broker who claims the ability to “beat the market.” The premise of these brokerage firms is they add value by stock picking, market timing and selecting actively managed funds. There’s precious little evidence supporting these claims, and vast research contradicting it.

A False Sense of Precision

So you can imagine my surprise when I read this comment from Paul Donovan, the “global chief economist” of UBS:

Economists should not make forecasts.

December always has a rash of economic forecasts for the year ahead. The reception areas at CNBC and Bloomberg TV are crowded with mobs of economists fighting to get their forecasts on air. But there are big problems with making precise economic forecasts.

Economic models are not precise. Models use lots of assumptions. Those assumptions may not turn out to be true. Models give a range of possibilities rather than a single, certain number. Economists know and understand these issues. However, the world of hashtag economics does not allow for all of this to be explained. It is difficult to warn about possibility ranges and underlying assumptions in 280 characters. This is why economists should not use Twitter. Economic views often give a false sense of precision, because the reporting of economics is simplified and shortened. That precision simply is not there, in our view.

Ignore All Predictions

Actually, while Mr. Donovan’s comments are most welcome, they understate the problem with forecasts. Here’s a glaring example of the unreliability of economic forecasts. According to this blog post, “In November 2007, economists in the Philadelphia Federal Reserve's Survey of Professional Forecasters called for growth of 2.4 percent for 2008, with only a 3 percent chance of a recession, and only a 1 in 500 chance of the GDP falling by more than 2 percent. GDP actually fell 3.3 percent.”

Think about the inaccuracy of this dismal track record. If economists were so terribly wrong in predicting the worst recession since the Great Depression, why should you pay attention to musings about what’s likely in store for investors next year or at any time in the future?

And if economists have no forecasting expertise, why should you rely on the advice of your brokerage firm when it dispenses views about stocks likely to outperform, where the market is headed or which actively managed mutual fund will generate outsized returns?

As financial journalist Jonathan Clements noted in this blog post, ignore all predictions. Don’t try to pick stock winners. Use index funds to own all stocks at the lowest possible cost. Clements correctly notes that broad diversification guarantees outperforming “most competing investors.”

Don’t expect to receive that advice from your broker at UBS or elsewhere.

Resource of the Week

The title of this article on Bloomberg View tells you all you need to know:  Wall Street Wises Up to the Folly of Forecasting.

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