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Forecasts and wishful thinking

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Forecasts and wishful thinking

Many years ago I was involved in what was the silliest consulting assignment I ever had. I was asked to forecast the inflation rate for each of the next 40 years. What made this assignment even more ridiculous was that six months after I submitted my report (a consultant rarely turns down a well paying gig), I was asked to revise my forecasts.

The assignment was silly because it was impossible for me to anticipate everything that might happen and impact the rate of inflation over the next 40 years. Why do I bring this up? I guess because I was inspired by two stories today, and one last week. One reported that 46 economists surveyed by the National Association of Business Economists in the U.S. are forecasting moderately stronger growth despite concerns over Europe.

The other was an op-ed piece by Todd Hirsch, a senior economist with ATB Financial, in today’s Globe and Mail. Among the three lessons he offered young economists were the following: “Don’t get caught up predicting the shape of what’s to come” and “don’t be afraid of those three words we seem to dread most: “We don’t know.””

Last week a study that followed recommendations made by Wall Street analysts found that their track record was only slightly better than 50%. In other words, investors could do almost as well by basing their decisions on a flip of a coin.

Hirsch offered good advice, however the advice is largely ignored by the users of the forecasts.

There are generally three types of forecasters. The first group consists of people who tend to be objective. The second consists of those who act as shills for their companies.  The third consists of perpetual pessimists.

The objective forecasters tend to focus on macroeconomic variables such as rates of growth, inflation rates, interest rates and unemployment rates. When the economic environment is stable, their forecasts are usually close to the mark, at least for one year out. But this state of affairs is uncommon, and their accuracy falls off sharply over time, especially during periods of instability. Moreover, these forecasters tend to be part of the herd of forecasters, deviating slightly from the “conventional” wisdom of the herd, and adjust their forecasts slowly and with a lag during periods of turmoil and increased uncertainty.

The shills hype up certain investments and do not always acknowledge that their companies have long or short positions in these investments. During the tech bubble in the 1990s, research analysts hyped up companies in order for their employers to win lucrative advisory work, even when they believed that the companies had no future. This still happens. But we also find shills for commodities, especially gold. And during the sharp run up in oil prices in the latter half of 2007, research analysts kept raising their price forecasts at the same time as their companies were taking long positions in oil even though the fundamentals did not support their “optimism”.

Then there are the perpetual Dr. Dooms – Nouriel Roubini, David Rosenberg and the die-hard believers in gold standing out among this group. According to these forecasters, everything that can possibly go wrong will go wrong, and asset prices, except gold, and the economy are continuously on the verge of collapse. Periodically they are right. But they are usually wrong much more often, and investors rarely get rich following their advice.

What does all of this mean? If you base your investment decisions on the advice offered by any of these three “expert” groups, you are likely to lose. Once in a while you, like they, will get lucky. But don’t bet on it!

The future is uncertain, and no one has the crystal ball to foretell the future.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.


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