How Reliable Are Financial Forecasts?
Every January, many in the financial industry make forecasts about what will transpire in the coming year. Market strategists, portfolio managers, TV commentators and the like eagerly share their predictions for everything from the stock market and economy to commodity prices and interest rates. It seems that the most outlandish forecasts are the ones which receive the most attention. For example, The Royal Bank of Scotland (RBS) published a research report dated January 8, 2015, in which it recommended to “sell everything except high quality bonds” and warned of a “fairly cataclysmic year ahead.” The report also warned that “advances in technology and automation were set to wipe out up to half of all jobs in the developed world.” [1] Not surprisingly, the report received quite a bit of attention in the financial press.
Should such forecasts be heeded? Should they form the basis for an investment strategy?
Our answer to these questions is a resounding “No” for one simple reason: no one knows the future. Every month The Wall Street Journal surveys more than 60 economists on various economic indicators. Even though these economists are highly paid and well educated, their track record is poor. For example, in January of 2015, the economists forecasted that the price of oil at the end of the year would be $63 per barrel. The actual price was $38, and no one thought the price would be below $40! The projection for the Federal funds rate at year end was 0.89% compared to the actual rate of 0.375%.[2] Economists and market prognosticators have been forecasting higher interest rate for years, yet we are still waiting.
In one of the most well-known instances of a forecast being entirely off the mark, in a speech before Congress in March of 2007, the then chairman of the U.S. Federal Reserve, Ben Bernanke, stated, “At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.” [3] In this instance, the most important and influential economist in the world was completely and utterly wrong about the most consequential economic event in a generation. How can this be? For another glaring example, consider a well-known book authored in 1999 by James Glassman and Kevin Hassett entitled Dow 36,000. At the time of publication, the Dow Jones Industrial Average (DJIA) stood at 10,318. Today, 17 years later the DJIA trades at 16,307; apparently it still has a ways to go. While the title of the book was provocative, the message was clear: load up on stocks because they were going to the moon, and fast! [4] Looking back, we know that within months of the book’s publication, the markets tanked and a painful three year bear market began. Investors who took the book’s advice were wiped out.
The point of this post is not to beat up economists or financial commentators. The fact of the matter is that the future has and always will be uncertain. No one has a crystal ball, so beware of those who act like they do. There will always be “experts” calling for a huge bull market while others are simultaneously forecasting an economic collapse. The point is that forecasts are entertainment at best and potentially a very costly distraction at worst. The good news for investors is that predictions of the future aren’t required in order to be successful. In order to meet financial goals, investors should focus on the things they can control, such as living within a budget, saving for retirement, minimizing taxes, investing with an appropriate asset allocation, risk control, minimizing costs and generally trying not to make foolish decisions. If investors spent more time focusing on these issues rather than how the stock market would perform over the next twelve months, they would be much better off.
[1] http://blogs.wsj.com/moneybeat/2016/01/12/rbs-warns-sell-everything/
[3] http://www.federalreserve.gov/newsevents/testimony/bernanke20070328a.htm
