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The Folly of Long-Term Forecasts


In late January, Brexit minister Steve Baker suggested the Treasury had put together 15-year economic projections designed to show “all options other than staying in the customs union were bad.” Though he later walked the statement back, to some, it supported suspicions of government agencies’ complicity in “Project Fear”—an effort to scare Brits out of voting to leave the EU.

In our view, though, whether or not civil servants monkeyed with the math is secondary. Even long-term forecasts (of the economy or equities) conducted in good faith usually err for a simple reason: The near future is difficult to predict, but the longer out you go, the more variables enter the equation. Moreover, we believe long-term forecasts aren’t actionable for investors, as markets generally don’t look further than 3 – 30 months ahead.

Economic and market analysis is not a hard science. Nevertheless, many forecasters build models of potential impacts to conduct experiments testing certain events or conditions. But humans build these models—humans with biases and preconceptions. Even conscientious number crunchers have them. Whilst the Treasury and BoE have taken a lot of heat for hyping Brexit risks, they weren’t alone—most pundits and experts were saying the same. Headlines from most major publications featured projections a Leave win would introduce crippling uncertainty, frighten away investment and trim growth. This illustrates the fact mere groupthink or shared false assumptions can produce shaky forecasts—no data manipulation required.

Accurate forecasts

Paying too much attention to the recent past is another forecasting pitfall. Models often extrapolate current trends into the distant future, even though they frequently come and go without warning. History shows this: For years, rising energy prices fuelled peak oil fears—given current consumption rates and allegedly dwindling recoverable supplies, the logic went, oil would run low and become prohibitively expensive. Then the rise of shale drilling unlocked new reserves, boosted supply and slashed prices. Many now speculate about “peak demand” instead. Similarly, during the dot-com bubble, widespread belief in a “new economy” based on clicks sent Tech shares soaring. A famous forecast for America’s Dow stock index to hit 35,000, made in 1999, fell prey to this error, projecting strong equity returns far into the future.

The UK’s Office for Budget Responsibility (OBR)—an independent agency charged with making five-year fiscal and economic projections—has also struggled to make accurate forecasts. For example, after measured productivity lagged the OBR’s projections for years, they slashed the gauge’s contribution in last November’s outlook. Expected growth sank, too, from 1.8 per cent annually over the next half-decade to 1.4 per cent. Setting aside questions of productivity’s usefulness as a metric—and the difficulty of calculating it—the stark revision illustrates OBR’s biggest problem: It makes predictions based on backward-looking data—a recipe for remaining behind the times. The same trouble stalks America’s Congressional Budget Office (CBO)—a nonpartisan agency tasked with analysing proposed legislation’s fiscal impact. Its history is full of wildly off-base projections for US budget deficits, interest rates, GDP and other measures. In the late 1990s, it projected then-strong economic growth forward, anticipating this meant then-existing budget surpluses would persist through 2009. But the 2001 recession hit, whacking tax revenues whilst the government cut taxes and boosted spending, increasing deficits. By the time 2009 rolled around, so had another recession, and the projected surplus had morphed into a $1.4 trillion annual budget deficit.[i]

Supply and demand for shares

This illustrates a huge flaw in forecasters’ extrapolations: They ignore business cycles. Unless you can predict when recessions will occur years from now and how deep they will be, forecasts for things like GDP growth, investment and trade are bound to err. Furthermore, gradual, structural shifts can emerge over time, boosting or lowering growth. Maybe popular “secular stagnation” theories turn out to be right, and years of low growth await—or maybe the opposite occurs. Or something in the middle. Statistical forecasts can help us imagine what the economy might look like down the road if a slew of assumptions held true. But they are mostly thought exercises.

For investors, economic forecasts are useful only if they help make investment decisions. But there is no automatic connection between economic growth rates and market returns. Instead, supply and demand for shares rule. In the near term, supply is pretty stable, so markets move on demand for shares. In turn, demand shifts based on how global economic and political drivers interact with prevailing sentiment. Reality surpassing expectations tends to lift shares and vice versa. In the long term, though, supply shifts matter most—and we aren’t aware of anyone who has successfully forecasted share supply. How many companies go public, buy back or issue more shares in 2028 is unknowable today.

Demand drivers aren’t possible to forecast that far out, either. This doesn’t just require projecting a dizzying array of economic data. It also demands knowing the state of political gridlock, regulation, the likelihood (and desirability) of major reforms and a host of other political factors. Then forecasting how investors would feel about those factors—all years in advance! This is imagination territory.

Hence why we wouldn’t get caught up in predictions—from the Treasury, OBR or elsewhere—of Brexit’s potential impact, for good or ill. Even if pessimistic Brexit forecasts eventually come true, equities don’t move today on potential outcomes years away. Media like to highlight these potential outcomes, especially if they are scary, but markets care about probabilities. Gaming probabilities past about 30 months is extremely difficult, so markets don’t try. We believe investors should emulate this.

This isn’t to say long-term forecasts are wholly irrelevant for investors. They can help you assess current sentiment and determine what outcomes might surprise. But don’t believe they are predictive or useful in making investment decisions.


8 Comments on "The Folly of Long-Term Forecasts"

  1. rockman on Fri, 2nd Mar 2018 1:37 pm 

    As pointed out many times here models can be very useful…if properly constructed. But not with respect to accurate future predictions. Every model is built on a variety of ASSUMPTIONS. Varying those assumptions individually to reasonable extreme end points is the real value of a model. A certain number of variables will have minimal impact on the model while others will dominate the final output. This allows a greater focus on those critical assumptions while avoiding wasting time on the less relevant components.

    Which is the primary problem I have with many models…including some here. I’m much more interested in the assumptions (and the impact of their variations) then the actual prediction of any particular model. Debating a model’s result is often pointless if one doesn’t understand the assumptions use to build it in the first place.

    Same old example: I have a coin I’ll flip. What are the odds of a head result? Most would say 50%. But I show you the recent history of flips for that coin: 19 heads in a row. Do you still ASSUME a 50% chance of heads flipping on the 20th attempt? Or do you consider your ASSUMPTION that it’s an honest coin (heads on one side and tails on the other) is full of shit? If someone here thinks that honest coin ASSUMPTION is still valid the Rockman would love to play poker with them. LOL.

    If one sees a model predicting the future price of oil that contains ASSUMPTIONS which are ridiculously implausible how much validity would you grant that prediction any credibility? Kinda like back in school: the teacher is more interested in seeing your work to get to an answer then just seeing your answer alone. At least a good teacher would.

  2. mck on Sat, 3rd Mar 2018 4:35 am 

    Pod has become infested with trolls and shills
    im outa here .

  3. Davy on Sat, 3rd Mar 2018 5:12 am 

    Estimating past data series in a mechanical extrapolation is not reality but we so often create reality with these predictions. We then use projections with subjective numerical assumptions to cloud reality even more. We then dress all this up in forecasts of future values of external factors we subjectively predict and project. Do you see the circular nature of all this? We are goal seeking the further off we go into these goal seeking exercises. We often discount or dismiss factors that are actually foundational. Systematic basis of economy and social structures are often considered a constant when reality says they are not fixed but in flux. Economies go bad and societies fail. We then feel free to seek our desired data in an emotional safety that controlled mathematical research provides.

    We appear to be nearing a point of profound change. We are approaching thresholds of change. Yet, we continue to look beyond with a habituation of a past of averages of growth and development. This linear thinking is intoxicating. It satisfies our deepest desires of accomplishment. This growth is hitting limits and the finitude of phase change is nearby. Yet, we continue to reach out with forecast, predictions, and projections to realize a future now. If the numbers agree then we have the optimism and confidence to proceed. It does not matter that the goals we have were a construction of our desires. We tell our selves this is true because of the science and math say so but we lie to ourselves with the application. We are bargaining with reality with goal seeking models.

    This is not necessarily wrong because great accomplishments occur from this. Creativity and innovation are made possible by these processes. What is wrong is when this process becomes obscured by a culture of this activity. When there is a pervasiveness of dreaming and fantasy camouflaged as science. We have a Ponzi culture of investments and activities that are poor investments when reality tested with honest science. When the majority of our visions that direct and control society are corrupted by poor wisdom of who we are and where we are going then bad things happen. They always have as witness by all past civilization that vanished. They have all ended with many similar characteristics. We have adapted that by saying ours is different. We are now modern and truly intelligent. We know it will end but we tell ourselves this is thousands of years down the road. Science will take us off this planet to colonize elsewhere. The thinking is always ahead and out there.

    To be fair we have had a series of good scientific studies that point to limits and problems with our modern globalized world. We are little more than a market based system grounded in a global liberal democracy of nations in competitive cooperation. This arrangement is dangerously close to overshoot but few are honest about this conditions. Those who are honest are on the fringe. Mainstream does not acknowledge we may have failed. Do you ever see commercials that are pessimistic? If they are they are motivating us to happy endings. Do we ever have true wisdom in the media? We have some documentaries and some good books but mainstream is characterized by consumerism and the pursuit of affluence. As we approach barriers to growth and as a shift away from affluence occurs how will we react? Will we continue to ignore the end of growth and affluence? Will we continue to forecast fantasy futures based on revised history with science denial? Even science is in denial today with solutions. Will we instead at some point find honesty and acceptance of decline and decay?

  4. Cloggie on Sat, 3rd Mar 2018 5:24 am 

    Pod has become infested with trolls and shills im outa here .

    “mck” who? How can you be outahere if you were never in to begin with?

    Brexit’s potential impact, for good or ill.

    As I recently verified yet again, while en route to Saint-Malo in Bretagne, it is possible to see the White Cliffs of Dover from the French side at Cap Gris-Nez:

    It would have been better for all involved if this view had been possible from Boston Harbor rather than from Normandy. Britain is Anglosphere, not Europe.

    Therefor Brexit is a God-send. Britain is leaving a political entity it should never have been a member of to begin with. The very right-wing French president Charles de Gaulle was right with his resistance against British membership. But they came anyway in the wake of 1968-leftist revolution and now they are leaving. It is the opening salvo of the coming break-up of the West.

    Britain wants Anglosphere to rule over Europe, but continental Europeans have different ideas…

    …and the continentals have a Russian geopolitical card they can play.

    But we can’t play that card yet, because in response, the American Deep State can play a far bigger geopolitical card, namely China.

    If a last minute anti-European US-Chinese alliance would come about, we would have more or less the situation of 1933 back, with Greater Europe rather than Germany surrounded by hostile powers and the American Deep State doesn’t need to prove that it is willing to destroy Europe if it enlarges their power. Right millimind, right Davy?

    Is the European situation hopeless? Far from it. The difference between 1945 and 2018 is that America has morphed from a glorious all-powerful winner into a depressed doomer country that deeply doubts its own future and direction in the face of its own (European-American) demographic demise. The divide between neocon-ruled Washington and the deplorables it rules over is enormous and approaching breaking point.

    From a continental European point of view Britain and its former colonial subsidiaries Canada, Australia and New Zealand are irrelevant. Only one Anglo country is important and that is America, the Anglo country where paradoxically the people of German descent are still the largest ethnic group.

    If we can drive a wedge between Washington and its deplorables we can create an identitarian alliance/culture circle that will dwarf everybody else (read: China and Islamic world). That’s the way forward for (Greater) Europe.

  5. David Shortbread on Sat, 3rd Mar 2018 9:42 am 

    True. Brain-dead extrapolation is at the heart of most modern doomer predictions. That kind of thing has just gotta stop! We’re better than that, people.

  6. dave thompson on Sat, 3rd Mar 2018 11:21 am 

    Human hubris will keep lots of people from seeing where we are headed, in the not to distant future. Pointing out the folly of endless growth on a finite planet comparing it to an wine vat with yeast feasting away. Humans will not fool mother nature.

  7. mck on Sun, 4th Mar 2018 4:42 am 

    So what is your agenda clogged ? is it to inform us that renewables will save the day and there is nothing to worry about. all will be taken care of? why bother unless you have vested interest. that would explain your constant and annoying trolling

  8. Cloggie on Sun, 4th Mar 2018 5:48 am 

    So what is your agenda clogged ? is it to inform us that renewables will save the day and there is nothing to worry about. all will be taken care of? why bother unless you have vested interest. that would explain your constant and annoying trolling

    I thought you were “outa here” as you announced 5 posts ago.

    I do indeed promote renewable energy, an absolute majority opinion in the world, with the exception of the US:

    But then again, the US are exceptional, eh?

    I never said that renewables save all problems, but at least our energy problems and that’s a start.

    Besides I have opinions on everything, many of which you apparently don’t like. That’s the risk you run when you join a discussion board, that’s usually not for the faint-hearted, like you, who announced his departure before he had ever posted anything (to my knowledge and memory).lol

    Could it be that YOU are the thought-police opinion-troll?

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