Seeing 20/20 into 2020?

Seeing 20/20 into 2020?

Following the market’s swoon last year, many investors became convinced that a recession was lurking right around the corner. After all, the stock market has proven to be a fairly reliable leading indicator before – and a steep sell-off is rarely just noise. Yet, the Federal Reserve quickly reversed course, stock markets responded with their best start to the year in over two decades, and the economy now seems to be on much firmer footing.

With the benefit of hindsight, last year’s market head fake appears to be one of the largest emotional disconnects from reality that we have seen over the course of this long bull market. Of course, hindsight is 20/20 and making rational predictions about the future is far more challenging. This reality begs the question of how much confidence should be placed in the ability of experts to predict the markets, particularly at a time of great debate about what the future may hold.

The answer to that question? It depends. Beyond the fiendishly complex world around us, one also has to consider not just what could happen but how markets will actually respond, with the most recent reversal in policy by the Federal Reserve being the perfect example. While markets cheered their new dovish tone, many investors – even if they had accurately predicted the Federal Reserve would become concerned with slowing growth – would probably have predicted, wrongly, that markets would have taken that news bearishly.

An expert’s crystal ball also tends to get much cloudier the further out in the future they try to see. To this end, The Economist recently published a study analyzing 20 years of market forecasts. It concluded that professional economists have the ability to peer into the immediate future with some accuracy, but this ability does not extend out much further than about six months or so. Beyond that point, economists missed GDP projections by approximately 0.8 percentage points. And when predicting almost two years out, they were off by a relatively significant 1.3 percentage points.

Economists also tend to be overly optimistic in general. The International Monetary Fund recently completed an internal audit of its own forecasting capabilities. The conclusion was that over the 25-year period ending in 2016, the organization consistently overestimated GDP growth by an average of 0.58 percentage points. And during times of great economic change, when GDP is contracting, the average projection for GDP growth two years earlier missed the downturn by a whopping 3.7 percentage points! So, if there is a recession lurking in 2020 and beyond, don’t expect to see it clearly from where we stand today.

So how do we think about market forecasting and trying to be anticipatory in light of these institutional tendencies and statistical outcomes? We understand the benefits and limitations associated with such projections and tend to think of the world in terms of probabilities, not certainties; and, in turn, we believe that this will let the markets, which typically change far more dramatically than the underlying economy in the short-term, create long-term opportunities for our clients.

We do know, with absolute certainty, that this cycle will eventually come to an end, and we continue to watch the data carefully as it unfolds. Until then, we continue to forecast an elongated economic cycle and look to take advantage of the inevitable bouts of volatility as they occur. Importantly, we remain cautious of the biases inherent in the system from those who would claim to see more clearly than reasonable into the distant future.

 

Sources:
“GDP Predictions are Reliable Only in the Short Term.” The Economist Graphic Detail 15 December 2018.
Kantchev, Georgi. “Beware Overly Rosy Forecasts on Economy.” The Wall Street Journal 07 June 2018.

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