If These Guys Can't Get Predictions Right - What Chance Do You Have?

"The best way to predict the future is to create it"
- Peter Drucker

The Fed.

Think of the brain-power, the computing muscle, the insight, the sheer vested interest the Federal Reserve, as guardians of the monetary policy of the richest country in the world, must have at its disposal to make economic forecasts . . .

Now consider how wrong those forecasts have been.

Dr. James Bullard, President of the St. Louis Federal Reserve Bank, spoke Friday before the CFA Society of Chicago. Central to his presentation, Ghosts & Forecasts, was an explaination of how FMOC forecasts are made, and how (in)accurate they have been in the last few years. The Fed's mandate focuses on two measures - employment and inflation. Consider inflation:




 The FMOC has undershot inflation for the last two years - after overshooting it in 2011. Even using its broadest predictor, the Fed was right only twice in the last six years.

Bullard's caveat is that, like Ebeneezer Scrooge and The Ghost of Christmas Present (The Ghost in the presentation's title), their mandate is to predict that which will come to past if the present course is unaltered. The Fed's job is to do that altering if call for, but consider that the Fed's inflation policy target was higher than their highest prediction even. Scary to think how off they would have been if they hadn't been driving policy at the same time.

Unemployment predictions were a little better, only missing half the time and only about as dismal as private forecasts (small comfort). GDP forecasts have been more accurate the last two years.

Click here for the entire presentation

All financial decisions involve prediction, explicit or implicit, yours or someone else's. Because they are part & parcel of portfolio allocation, it's important to recognize their limitations and to temper your reliance on them coming true. This is why you save as much as you can. This is why it is wise to avoid 'sure things' - they don't exist. This is why diversification is prudent move. Because if the Fed can't get economic predictions right, if 'Blue Chip' economists can't forecast employment, are you going to bet your future on your or your broker's guess?

The Problem with Analysis

Oil's down. Now what?

In last quarter's Advisors' Outlook I highlighted the recent resurgence of domestic energy production as a long-term trend with unknown ramifications as far as the U.S. economy was concerned. OPEC responded by attempting to force U.S. production into unprofitable territory by maintaining the status quo on production levels in the face of lagging demand. The result has been oil prices below $50/bbl and gas prices that start with a '1'.

I would have thought this would be a good thing for the economy and markets. Except for the oil producers and support services, oil is in input cost for everyone else. A decline in the cost of production should result in higher profits or pass-through savings to the ultimate consumer. Good things, right?

And lower fuel costs should free up a piece of the consumer's budget to stimulate the economy elsewhere. People may use low cost gas to shift to bigger vehicles eventually, but in the short run demand is fairly inelastic - I'm not going to change my commute weekly as gas prices change. (This argues against lower oil prices being disinflationary as well. Though technically correct, the big worry of disinflation is that consumption slows while consumers wait for prices to fall further. I don't know about you, but I pretty much pay what the pump says when I'm on 'E' - up or down).

So why did the market fall nearly 2% on Monday with 'dropping oil prices' pegged as the culprit?

The mixed picture is confounding investors. The Standard & Poor’s 500 Index of U.S. equities fell 1.9 percent on Jan. 5, the biggest decline since October, as oil brought down energy shares and stoked concerns that global growth is slowing. - Bloomberg

I have no idea. Honestly, I still think benefit accrues to the consumer short term and long-term production trends favor the U.S., but the markets think otherwise. Or at least they did on Monday. Incidentally, an Oxford Economics, Ltd. analysis in the same article, agrees with my favorable assessment, at least about U.S. GDP.

As an investor, this leaves me in a bit of a pickle. Either:

  1. My analysis (on this point at least) is wrong -or-
  2. Conflicting analyses make it hard to figure out who is right
In either case, I'm better off with a strategy of a targeted asset allocation, letting the markets tell me when to buy or sell through rebalancing. The alternative is to identify someone who is a crack analyst, but for that to work, you have to identify analysts skilled in all aspects of the economy and know to balance their respective inputs. Not easy (or cheap if it truly exists) either. 

For timing to work you have to have accurate predictions, accurate analysis, and the market has to eventually agree with you. Best to avoid timing at all.


For the full Bloomberg article, click here.