What Economic Forecasting Can Do To You

Have you ever stopped to think about why we pay so much attention to economic data and predictions?

After all, as mid-twentieth century economist John Kenneth Galbraith once said, “the only function of economic forecasting is to make astrology look respectable!”

If you’ve paid attention to economists and their predictions for any length of time, the only conclusion you can arrive at is that they are wrong far more than they are right. It’s not even close.

Why then does the financial media constantly agonize over every slight movement up or down in dozens of economic indicators from new home sales to the balance of payments, and from manufacturing capacity utilization to the producer price index?

This is a very, very important question.

Think about it. We all labor under the delusion that if we can somehow figure out what the economy is going to do next, we can then anticipate how markets will respond.

In other words, we study the economy, not as intellectual entertainment for its own sake, but as a predictor of markets.

A False Premise

Let’s take a moment to break this down to see just how intelligent this activity is.

For starters, the premise is, “if we can figure out what the ‘economy’ is going to do next.”

We can’t!

No one ever has with any consistency. That’s what Galbraith was trying to tell us. Therefore, any conclusion we draw from this premise will be wrong no matter what it is.

But, for fun, let’s assume that we could anticipate the economy in the short to intermediate term just once in our investing careers. We would still have no earthly reason to suppose that we had a handle on the trajectory of the stock market’s next important move.

For very recent historical perspective, let’s go back and examine the incredible disconnect between U.S. GDP (gross domestic product) and the stock market since the end of the Great Recession in 2009.

The S&P 500 stock market index bottomed out at 677 in March 2009, anticipating the end of the recession, which the National Bureau of Economic Research says took place in June of that year.

Assume, for a moment, that sometime between March and June you asked a prominent economist what GDP growth was going to be in the next five years, and by some miracle, he knew.

He would have told you that GDP growth through 2013 was going to range between one and two percent a year, and that unemployment would never get below seven percent.

In response to that forecast of a painfully slow economic recovery, you would have likely concluded that stock market prices couldn’t possibly gather any real steam given this forecast of an economy that’s virtually on life support.

And, the “logical” conclusion from this forecast is that you would decide to keep your investments in cash until the economy gives you much stronger signals.

Given that those “signals” you were looking for never presented themselves during the ensuing five years, in all likelihood you’d still be holding everything in cash meaning you would have missed one of the great market recoveries not just of our time, but of all time!

In Spite of the Economy

Stock prices didn’t rise in response to the economy, but in spite of it.

They went up in response to the same forces which have always driven them in the long run: the dramatic post-crisis increases in corporate earnings, cash flows, dividends and cash positions.

The lesson to be learned about this is that long term, goal focused, patient, disciplined investors learn over time to tune out all economic reporting and current events.

That certainly flies in the face of the message you hear from the dominant media culture, and likely among the majority of those you interact with.

However, what any objective and rationally thinking individual has discovered through painful trial and error is that not only won’t the economy tell us what market prices are going to do. The economy won’t even tell us what it’s going to do!

What The Majority Did

In the first half of this year, there have been two market ‘hiccups’. The first took place between January 15th and February 3rd where we witnessed the S&P 500 fall 5.76%.

As they are very good at doing, The USA Today instantly noted that more than 50% of the companies in the S&P dropped more than 10% signaling that we were in correction mode. (Of course, they failed to mention that the price of 50% of the companies dropped significantly less than 10%, thus the reason for the “average” price drop of 5.76%).

What’s important for us, however, is what the majority of investors did in response to this news. The week of February 5th (right at the bottom) saw $18.8 trillion dollars withdrawn from U.S. stock funds and ETFs, the largest weekly withdrawal in history!

It was also the largest weekly inflow to bond funds ever recorded. A whopping $10.7 billion.

In May, when the Nasdaq took a double digit hit, another $7.7 trillion was withdrawn from equity funds.

Why This Is So Sad

DALBAR recently published their 20th Annual Quantitative Analysis of Investor Behavior which illustrates the sad long term consequences of the two recent examples of poor investing behavior above:

  • The 20 year average annual return of the S&P 500 Index: 9.22%
  • The 20 year average annual return of investors in stock mutual funds: 5.02%

Translation: the stock market produced a return of 9.22% per year, but the average person who invested in the stock market only earned 5.02% due to “how” they invested, i.e. what they did.

At the end of those 20 years, that’s the difference in your $1 million retirement fund being worth $5.8 million vs. $2.6 million.

Control What You Can Control

As Warren Buffet said, “Since the basic game is so favorable, Charlie and I believe it’s a terrible mistake to try and dance in and out of it based upon the turn of tarot cards, the prediction of “experts”, or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

The bottom line is that it’s fruitless to agonize over what the stock market is going to do in near future.

In the short run, it’s always been completely irrelevant to your financial future.

Instead, focus on what you can control.

Committed To Your Relaxing Retirement,

Jack Phelps

The Retirement Coach

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