An astonishing record of failure

At APW Partners we do not rely on forecasts from economists or stockbrokers when developing and implementing client strategies.  That’s because “expert” forecasts have a history of being less reliable than random guesses. 

A recent article by Tim Harford in the Financial Times provided further insight on the accuracy of economic forecasts[1].  We’ve summarised the most revealing results below:

  • In the 2001 issue of the International Journal of Forecasting, an economist from the International Monetary Fund, Prakash Loungani, published a survey of the accuracy of economic forecasts throughout the 1990s. He reached two conclusions.

    The first was that forecasts are all much the same. There was little to choose between those produced by the International Monetary Fund (IMF) and the World Bank, and those from private sector forecasters. Nobody wants to be an outlier because it’s better to be wrong with everyone else rather than be wrong by yourself.

    The second conclusion was that the predictive record of economists was terrible. Loungani wrote: “The record of failure to predict recessions is virtually unblemished.”

    This is extraordinary, as the GFC was firmly established when these forecasts were made.   By April 2008 Northern Rock had already been nationalised in the UK and in the US Bear Stearns had already collapsed.

  • When Loungani extends the deadline for forecasting a recession by five months to September 2008, the consensus remained that not a single economy would fall into recession in 2009.
  • By September 2009, the year in which the recessions actually occurred, the consensus predicted 54 out of 49 countries would be in recession – that is, five more than there were. And, as an encore, there were 15 recessions in 2012. None were foreseen in the autumn of 2011 and only two were predicted by September 2011.
  • We should not blame economics alone for our inability to peer into the future of a complex world. In 2005, Philip Tetlock, a psychologist, published a landmark work with the title Expert Political Judgement. Tetlock found that throughout the 1980s and 1990s, political and geopolitical forecasts had been scarcely better than guesswork. It made little difference whether the forecaster was an academic, journalist or diplomat, a historian or a political scientist.
  • Why are forecasts so poor? The chief explanation is that the economy is complicated and we don’t understand it well enough to make forecasts.
  • Ben Chu, economics editor of The Independent, recently took a look at the UK recession of the 1990s in the light of two decades of data revisions. From the vantage point of 1995, the economy in late 1992 was slightly smaller than the economy in early 1988. But today’s best guess is that the economy of late 1992 was almost 6% larger than in early 1988. The Office for National Statistics has substantially revised its view.

    Not only is it difficult to forecast the future, then – interpreting the past isn’t straightforward either.

  • A second explanation for forecasting’s fallibility is that there is little incentive to do better. The kind of institutional chief economist whose pronouncement makes it into Consensus Forecasts will stick to the middle of the road. Most countries, most of the time, are not in recession, so a safe strategy is never to forecast one. Of course there are the mavericks who receive media attention for making provocative predictions and are lionised when they are right. Their incentives are different but it is unclear that their overall track record is any better.

The obvious conclusion from this article is that forecasts should not be taken seriously. 

What we do know is that stockmarkets will inevitably continue to go through bull (i.e. positive) and bear (i.e. negative) periods into the future.  We don’t know the exact timing, but we need to prepare for both: investors should want to participate in the positive returns financial markets produce over the longer term, but also maintain an appropriate asset allocation and sufficient cash reserves to tolerate volatile markets so they don’t need to sell assets at distressed prices.  We will discuss this further in our next article.


[1] ‘An astonishing record – of failure’, Tim Harford, 30 May 2014, Financial Times


Author: Rick Walker & Greg Keady

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