22
Aug
2023
man with a laptop facing a difficult choice

Why it can be futile to trust economic and stock market forecasts

The whole process of making your own predictions or being guided by the predictions of others is a key part of our lives.

From what the weather will be like tomorrow to how long it will take to drive to a certain destination, forecasts and estimates are part and parcel of what you do and when you do it on a daily basis.

At that level, the worst outcome you might face is getting caught in a rain shower without an umbrella or arriving late for a meeting.

However, problems can arise if you start relying too heavily on predictions when planning your financial future. This applies in two key areas where such predictions are commonplace: economic outlook and investment performance.

Read more about both, and why you should not rely on either when it comes to planning your long-term financial future.

Economic forecasting: “making astrology look respectable”

Economic forecasts often hit the headlines when we are facing bad news and economic headwinds. The temptation is to look for the reassurance that comes from someone telling you that things will improve.

However, some top economists have previously demonstrated a rather jaundiced view of the forecasts of their colleagues.

For example, the Keynesian economist, John Kenneth Galbraith, believed that “the only function of economic forecasting is to make astrology look respectable”.

At the other end of the economic spectrum, arch-monetarist Friedrich Hayek wrote The Road to Serfdom, which was said to be Margaret Thatcher’s guiding economic text, and was equally dismissive.

While accepting his Nobel prize for economics in 1974, he admitted that the tendency of economists to present their predictions with a certainty usually reserved for scientific analysis was misleading and “may have deplorable effects”.

Multiple variables make forecasting difficult

One issue with economic forecasts is that they depend on multiple linked variables. After all, economic output represents the aggregated activity of billions of people so there is plenty of scope for the unexpected to happen.

A small change in just a few factors can blow even the best-informed predictions off-course.

There is also the problem that many forecasters tend to think the same way, and there can be a big reluctance to go against accepted opinion.

As evidence of this, a Guardian report confirmed that Prakash Loungani, an analyst at the International Monetary Fund had analysed the accuracy of economic forecasters and found that economists had failed to predict 148 of the past 150 recessions.

Part of the problem, he surmised, was that there’s little reputational gain to be had from swimming against the tide, and a reluctance to stand out from the crowd by adopting a potentially unpopular contrarian position.

Human behaviour is an unpredictable variable

Some economic orthodoxy is accepted without question. For example, raising interest rates is an agreed method of bringing down inflation because increased borrowing costs results in individuals and businesses spending less, with a consequent reduction in demand.

But what economic analysts cannot as easily account for is how some human behaviours – such as greed and panic – can upset even the best predictions.

Perhaps the biggest, and most notorious example of greed in this regard exposing the fallibility of economic forecasting came after the 2007/08 financial crash. At Congressional hearings into the causes of the crash, the chair of the Federal Reserve, respected economist Alan Greenspan, was forced to admit that “the scenario that led to the crash did not appear in our projections”.

Fund managers struggle to beat the market

In the same way that economic forecasts can be prone to inaccuracy and can fall victim to irrational behaviour, there is a similar story when it comes to forecasts of the stock market by those who earn a living from predicting future investment trends and outcomes.

According to Wealth Within anyone looking to become an investment trader eventually comes across the statistic that 90% of traders fail to make money when investing in stocks and shares.

It’s not just traders who struggle for investment success. Even experienced investment fund managers, with teams of researchers and analysts behind them, can face the same problems. Like anyone, they can be susceptible to human error, as well as being at the mercy of unknown outcomes based on unpredictable behaviour.

For example, a 2022 Morningstar report over the previous decade revealed that only 24% of equity fund managers have been successful.

How this relates to financial planning

My job as a financial planner is not about predicting the economy, or which investments will outperform others.

To sum it up very simply, my role is to look at outcomes, and not to search for outperformance.

I will always tell you that it’s not possible to beat the market with any regularity, and that the best investment outcomes stem from the time your money is invested in the market and not trying to time the sale or purchase of specific assets.

From an economic point of view, at times you will face financial headwinds. When that happens, my advice will always be to ensure your plans and finances are robust enough to withstand the storm. I’ll also suggest some short-term measures that can help you in that regard.

Get in touch

If you’d like to talk through any of the investment issues you’ve read about here, then please get in touch.

You can call me on 07769 156 250.

Please note

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Foster Denovo Limited is authorised and regulated by the Financial Conduct Authority.