Caution — forecasters at work

Posted by TEBI on December 10, 2020

Caution — forecasters at work


Stock market forecasters have been in demand this year, and they’re going to be especially busy in the next few weeks. We’re reaching reaching that point in the editorial calendar when financial journalists are tasked with writing a year-ender. These typically combine sage retrospectives of the year just past with musings on what to “watch out for” in the coming year.

Often these articles are tossed together before everyone goes on holiday to fill gaps in the business pages over the break. They appear under headlines like “Your Investor Roadmap” or “Top Ten Threats and Opportunities for the Coming Year”.

However, the best and certainly the most entertaining way of reading these “market outlooks” is after the fact. This is no reflection on the skills of the analysts, mind you, but merely reinforces the pointlessness of speculation.


The year that wasn’t

For instance, in early January, Bloomberg published a piece entitled Almost Everything Wall Street Expects in 2020. This brought together the expectations of the best and the brightest in the investment banking, fund management and broking world.

The overwhelming view shared among the experts was that the double-digit returns of 2019 would be hard to repeat. The world would avoid recession, many said, with a modest and broad-based recovery and solid, if unspectacular, gains from risky assets.

You may not be surprised to learn that none of this esteemed forecasting panel predicted a global pandemic. None foresaw the virtual shutdown of many economies or the descent of much of the world into its worst recession since the 1930s.

And their failure to do so is understandable. After all, how can you accommodate such a rare external shock into your model? Many forecasters may include a global pandemic in their list of potentially risky events, but how do they quantify that risk?


Predicting news, predicting markets

But let’s pretend for a moment that some forecasters had predicted COVID-19, the associated shutdowns and the implosion of economic activity. In those circumstances, what do you think their prognostication for the markets would be?

One could reasonably wager that few of them would have picked that in those circumstances, global stocks would, after plunging 30-40% in the space of weeks, recover in equally spectacular fashion to hit record highs toward year’s end.

How many would have forecast that crude oil would hit 20-year lows? How many would have picked that gold prices would briefly hit record highs above $US2000 an ounce? Who would have forecast a near meltdown in the US Treasury market?

And which of our forecasting panel would have countenanced that western governments, only a few years after preaching fiscal austerity, would let public deficits surge by an average 9% of GDP?

Perhaps, after the relatively recent experience of 2008-09, economists might have predicted large scale monetary policy easing and government bond purchases by central banks. But who would have picked those institutions lending directly to businesses and backstopping of hundreds of billions of dollars in corporate debt?


Every crisis is different

The COVID-19 crisis of 2020 was altogether different than the global financial crisis of a dozen years before. The latter event originated in the banking system and derivatives markets. This one was a health crisis that morphed into an economic crisis and at one point threatened the financial system itself.

Medical professionals for several years had been warning of a global pandemic approaching the severity of the 1918 Spanish influenza. But few financial market forecasters put it high on their list of left-field events. It certainly didn’t feature in this year’s panel.

So it is worth exercising a large dose of scepticism when you are confronted with the inevitable market outlooks for 2021. It’s a tough business being a forecaster. First you have to predict the news. Secondly you have to predict how the market will react. The fact is that no one has been shown to be able to do that, at least not with any consistency.

They may think they have covered every permutation or combination in their list of possibilities for the coming year, but there will always be a residual level of uncertainty. And that can be a hard pill to swallow.


Forecasters versus planners

So if the future is unknown — even by the best forecasters — and if even the most meticulous financial plan can be undone by bad luck, what is an ordinary investor to do?

Well, it starts with focusing on what you can control and working with a financial planner who knows you and your goals. A good planner can get you to imagine how you might react if your portfolio were to fall 30-40% in value in the space of a few weeks. What can you do to prepare for such an event?

In March this year, we saw the benefits of discipline and diversification. Those who capitulated and went to cash back then and stayed there would be rueing missing out on the 50%+ recovery in equity markets since. In the meantime, for diversified investors, bonds continued to play their role, cushioning the fall in equities.


Can you handle it?

Can you deal with the sort of volatility we saw in March? If not, a planner can help you build a portfolio with fewer wild swings, albeit at the expense of lower expected returns. At the very least, a planner can figuratively hold your hand through the tough times, while maintaining your chosen asset allocation.

No one knows when the next crisis will be, what form it will take or when it will strike. What we can say with some confidence is there will be another one.


The virtue of a plan

What a sound financial plan provides is not the prospect of certainty — no plan can do that — but a structure for making clear-eyed decisions under pressure. It provides a strategy to help you stay focused on your goals, while rebalancing as required, and a reserve of cash to deploy in emergencies as needed.

The bad news is that there are cracks in the crystal ball. The good news is that with the right plan and a good adviser no crystal ball is required.



Here are some other recent posts you may have missed:

Five ways to develop a millionaire mindset

Stocks are risky no matter how long the horizon

Making the most of working from home

2020 and the danger of extrapolation

Why most Robinhood traders earn lousy returns

Practising what you preach



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Image: Justus Menke via Unsplash


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