How good are you at forecasting?
Robert Skidelsky
Friday, October 22, 2010

The efficient market theory states that shares are always correctly priced. This assumes perfect knowledge of the 'fundamentals' which determine the value of shares. A year ago I set a little quiz to a small group of directors - seasoned veterans of financial markets. I asked them to predict the rate of inflation, annual GDP growth, 10 Year Treasury yields the price of oil a year's hence, and the share price of their company. I then compared the outcomes with the predictions. Twelve out of thirteen overstated the growth rate of the economy. All overestimated the yield of 10 Year Treasuries. Ten out of thirteen overestimated the rate of inflation. For example, the average predicted growth rate of the US economy was over 3%. In fact it was 1.7%. The average predicted inflation rate was 2.9%. In fact it was 1.10%. It followed that the directors also over-predicted the share prices of their companies.

In short, there was a general expectation that recovery – and hence the rate of inflation, the recovery of the stock market, etc – would be much stronger than it turned out to be.

The conclusion seems obvious to me. We actually don't know what the value of these variables will be in a year's time, much less in five years' time. Uncertainty is a fact of life. Normally our estimates of yield based on 'fundamentals' will not be too far off. But, in a situation such as the present all bets are off. What will happen next year? Readers of this blog may venture their own predictions of the rate of inflation, annual GDP growth, 10 Year Treasury yields, the price of a barrel of crude, and the level of the Dow Jones index in a year's time. Or you might want to predict the British equivalents instead. Since I have no divine insight, I can't mark you right or wrong now. But if you explain the reasons for your predictions I will comment on them.

Comments:

By Vladimir Gagic (Phoenix, AZ) on Mon 02 May 2011 - 22:47

Dear Mr. Skidelsky:

One thing that I have always wondered, is it impossible to pick stocks better than the market because the market is efficient and thus random, like A Random Walk Down Wall Street; or is the the market inefficient and thus random, like Fooled by Randomness? How would we tell the difference?

Also, if I may add I greatly enjoyed your Very Short Introduction to Keynes and Return of the Master. I am now starting the third volume detailing Keynes in America of the longer biography. I have not yet found the first two volumes locally. The “not so special relationship” is particularly interesting!

I enjoyed your work even before I found out you resigned your post because of NATO’s illegal war against Serbia. I can thus add I greatly admire your work, and even more your beliefs.

Thank you,

Vladimir Gagic

By Robert Skidelsy on Fri 29 Oct 2010 - 11:17

Dear Ed,

Your reasons are excellent, on assumption that there’s no change in policy. Like you I hope they are too pessimistic and that something will turn up. Let’s have another look at your forecast in a years time.

Sincerely,
Robert

By Ed Beaugard (Amherst, Massachusetts) on Wed 27 Oct 2010 - 18:39

I just wanted to add that my guesses about where the economy will be in October, 2011 is an OPTIMISTIC forecast. It’s much more likely to be worse, provided austerity policies go through in force after the November elections as promised. As Paul Krugman has said recently, the chance of catastrophe is not negligible.

By Ed Beaugard (USA) on Tue 26 Oct 2010 - 14:50

Dear Mr. Skidelsky,

Okay, here goes for the U.S. for October, 2011:

Most of this is based on my belief that the Republicans will win control of the House and probably the Senate on November 2nd. This will mean:

1) the dumping of ~(10-12) million people directly into poverty/destitution over the next six months as Federal unemployment extensions end.
2). rapidly increasing layoffs of state and local employees as aid to states ends.

This will end the “recovery” fairly soon in the States, producing another recession or no growth. QE2 will have no effect, as the credit system is still broken(zombie banks), so inflation will remain at 1%, perhaps even negative(deflation) a year from now.
Growth in GDP will be non-existent, 0% or negative, maybe even -1% per year. 10-year Treasury bonds will have a low yield, due to Mr. Bernanke’s QE2, but again, this will have no effect on the real economy.
The price of oil will be lower, although the actions of speculators can have very large effects. I would say that it should drop as economic contraction takes hold across the world, say $40/barrel, but again, commodity speculators may have some effect on this.
The Dow Jones will probably be mostly unchanged, maybe below 10,000 but not by much, say 9000.

October, 2011:

Inflation: .5%
GDP growth: .25% or less
10 year Treasury Bonds: .5%
Price of oil/barrel: $40
Dow Jones: 9000

Of course, I hope I’m wrong and things turn out much better, but there is little evidence for a more positive outcome, in my opinion.

Sincerely,
Ed Beaugard

How good are you at forecasting? Robert Skidelsky Friday, October 22, 2010

How good are you at forecasting?
Robert Skidelsky
Friday, October 22, 2010