"Kee" Points with Jim Kee, Ph.D.
U.S. Data: Light week, but overall data continue to support an improving labor market (declining weekly jobless claims) and an improving housing market. In fact, the latest Wall Street Journal Forecasting Survey indicates an upturn in participants' outlooks. First quarter U.S. GDP is expected to come in at an annualized rate of 2.25%, growing by a total of 2.5% for 2012. In other words, GDP growth for 2012 should be in the 2%-3% range. Inflation is expected to fall slightly while bond yields for the 10 year Treasury are expected to rise by 65 basis points at year's end. That reflects an expectation that bond yields will be driven by the underlying real rate – a function of continued moderate expansion – not by higher expected inflation. Unemployment is also expected to gradually improve, dropping to 8.2% by December (La Jolla Economics). It appears that jobs data over the past few months is most responsible for the increased optimism among professional forecasters.
Forecasting in general: 2011 was a pretty good year to observe the limitations of professional forecasters. The Federal Reserve employs hundreds of Ph.Ds, as does the IMF and World Bank. All have pretty much upgraded or downgraded their forecasts based upon the latest data releases throughout the year. Nothing wrong with that, but it is helpful to recognize that this is as much an exercise in extrapolation as it is of forecasting. In fact, two professors, one from Oxford (Jerker Denrell) and one from New York University (Christina Fang) recently (2010) published a paper that analyzed the Wall Street Journal Survey of Economic Forecasts. They concluded that success in forecasting, that is, making a "big hit" that the consensus missed, was an indicator of poor judgment! The authors found that the poorest forecasters made the most extreme predictions. And because poor forecasters were more likely to make extreme forecasts, "they are also more likely to make extreme forecasts that turn out to be accurate." (Journal of Management Science). Anyone who has ever tracked a "guru" for any period of time experiences this. Gurus get that status by being at odds with consensus in a visible way that turns out to be right, but they typically fail with the follow-up act (e.g. Nouriel Roubini advising against stocks at the March 09 bottom, or Bill Miller suggesting that it was gold, not housing, that was in a bubble back in 2005). The important lesson here, I think, is to avoid the subsequent pattern of then finding another guru (until he or she blows it), essentially going from guru to guru. I've seen this pretty frequently throughout my career. That's why I'm such a big fan of relying on an investment process rather than an investment guru – particularly when uncertainty is high.
Looking globally, there seems to be a growing sense that "tail risks" (big negative shocks) have diminished. In Europe, Greece seems more likely to avoid a disorderly default, as the latest bailout plan includes an offer for existing Greek debt holders to exchange their debt for new 30-year securities with new (lower) coupon payments. The details are complex and the deadlines vague, but overall this is part of the "tough medicine" (the so-called haircut given to existing debt holders) that is a necessary prerequisite to rest-of-the-world aid. The European dynamic right now is an interesting one: G20 leaders (> 80% of world GDP) are hesitant to extend loans to Europe until Europe does more on its own. That's because, overall, Europe's debt/GDP ratio is actually slightly less than the U.S.'s, so it is economically capable of doing more on its own. But politically, the voters of solvent countries like Germany oppose bailing out countries like Greece, while the leaders in those solvent countries (e.g. Angela Merkel) fear a contagion effect and disorderly default (which would be catastrophic economically) if they don't help. So far it looks like markets are optimistic. Global demand for Euros is increasing (Financial Times), a bullish sign of confidence regarding the European situation. This is corroborated by global risk indicators, which have been improving.
Posted on Tue, February 28, 2012
by Jim Kee, Ph.D.