The Halo Effect: Bad Forecasts by Billionaires

Don’t Believe Billionaires’ Predictions
Sam Zell’s warning of a looming recession probably isn’t any more valid than his previous economic forecasts.
Bloomberg, December 18, 2015

This week, the real estate mogul and billionaire Sam Zell said, “There is a high probability that we are looking at a recession in the next 12 months.” The culprit, he told “Bloomberg Go,” was the strong dollar and slowing global trade, the beginnings of layoffs at multinational companies and a general lack of demand. The bears of the blogosphere dutifully repeated the forecast. (To its credit, most of the mainstream media ignored it).

Regular readers probably already know where I am going.

But this example is an opportunity to take apart a forecast to see what makes it tick. Let me preface this column by noting that Zell is a terrific real estate investor. His track record as an opportunistic buyer of “distressed properties” and his understanding of the optimal time to sell are legendary. According to Forbes, he earned the nickname, the Grave Dancer, in “the ’70s, when Zell penned an article attributing his success to dancing on the skeletons of other people’s mistakes.”

As a forecaster, however, he is no better than anyone else. This points to a two-fold problem: Many people who achieve success in one sphere are emboldened to make broad pronouncements. And listeners, impressed by the obvious business success, tend to believe the forecasts, often to their financial detriment.

Blame the halo effect, the tendency for a person’s success or positive traits in one field to “spill over” into unrelated areas. The term was coined by Edward Thorndike in a 1920 paper, “The Constant Error in Psychological Ratings,” but came to prominence with publication of Phil Rosenzweig’s 2007 book, “The Halo Effect (and Other Business Delusions That Deceive Managers).” Others, such as Michael J. Mauboussin with “Think Twice“ or “Success Equation,“ showed how luck can be mistaken for skill.

If this had been Zell’s first recession forecast, I likely would have missed it, but he has made similar calls that have not worked out especially well.

“We’re Heading for Recession,” he said in October 2012. We weren’t. At the time, Zell was supporting Mitt Romney, the Republican presidential nominee, and the election was one month away. Perhaps a bit of confirmation bias was at work.

In September 2008 — after Lehman Brothers collapsed — Zell warned that a recession was likely in 2009. His forecast was wrong the moment he made it — the recession was already under way: It had started in December 2007 and would end in June 2009.

In 2007, Zell said at the University of Pennsylvania’s Wharton School: “We’re not really in a quote ‘credit crunch.’ I think what we are in is a ‘confidence crunch’.” Except we were in the middle of a credit crunch that was about to get much worse. Zell added, “Despite the fact that we are in the middle of a recession, the real estate industry balance sheet has never looked better.”

Um, no.

I suspect that this time, there also is a confirmation bias, but not a political one. It was his book talking. We learned recently that Zell is selling some of his apartments.

It is natural that after a sale, regardless of the reasons the decision was made — valuation, data analysis, weakening economic backdrop — the seller would become negative. Hence, this is less a forecast of a recession than a confirmation and reiteration of that prior sale.

If you need further evidence that forecasts are wastes of time, see this, this, this, this, this, this, this, this, this, this and this. The failure rate of trying to accurately assess where a specific asset will be priced or the level of an economic metric — at a specific date — ensures that most attempts are exercises in futility. Thus, given that terrible track record, it is only logical to deduce that there has to be another goal beyond the price prediction. Marketing is usually the driver.

My colleague, Ben Carlson at A Wealth of Common Sense, reminds us of this. In his “Remember When” feature, he lays out a long list of terrible events that were predicted but didn’t occur. He admonishes us to “Remember these types of predictions the next time you hear a market prognosticator tell you they know what’s going to happen in the future. They don’t.”

Words of wisdom.

Originally: Don’t Believe Billionaires’ Predictions

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I originally published this at Bloomberg on December 18, 2015. All of my Bloomberg columns can be found here and here.