"Economists don't forecast because they know, they forecast because they are asked." -- J.K. Galbraith
Happy new year! It's a new year and a new time. this is the time of year when opinions and forecasts are trotted out. Experts predict. And through much retelling, predictions seem to become near-fact.
As members of the financial community we are frequently asked for our projections. The truth, that we don't know the future, is always unsatisfying to the questioner. But that is not near-truth. It is truth. Dear reader, I probably don't need to remind you that we at HBA have experienced many false dawns -- as well as surviving many catastrophes which never happened. The frequency of these occurrences has been enough to scold us into silence at best, or a great degree of circumspection at worst.
Consider the plight of the pool of "Bloomberg Economists". December of 2013 this pillar of financial journalism polled 67 economists as to their view on the direction of interest rates. All-- 100% -- every single one of them-- foretold of higher and higher interest rates. Right out of the gate interest rates fell. And they continued to fall through the first half of 2014 (bond prices rallying). June 2014 was the time for a reprisal. Bloomberg again conducted the poll, this time with 69 economists responding. In spite of the dizzying rally in bond prices (interest rates falling), again 100% of those polled saw higher interest rates at year end.Well, as 2014 has come to a close, 100% of the "experts" were 100% wrong: Interest rates fell across the yield spectrum, making long-dated US Treasuries the best performing asset of 2014. As we start 2015, a similar backdrop is already in place: At the start of 2015, 71 of 71 economists polled by Bloomberg Business Intelligence have predicted higher interest rates by year end. They may ultimately be proven correct, but so far yields have fallen out of the gate at the fastest pace since the market collapse of 2008.
I don't mean to pick on the Bloomberg economists (really!). Consider the price of oil. West Texas Intermediate peaked on June 20, 2014 at a price of $107.26 per barrel. A mere 6 months later, the price is 56% lower at $47.50 per barrel as of mid-January. No economist, oil expert, or oil analyst that we have found predicted such a price rout. In the aftermath of this decline in the oil price, much confusion reigns. Yet, on form, and without pause the "experts" have again stepped forward with their forecasts. And, as usual, almost all forecasts stick very closely to the (new) current level of prices. Both of these examples illustrate the extreme difficulty of factoring in all relevant considerations into a complex real-world analysis.
Even if a forecast is met with success, there remain ways in which it can be viewed as wrong. Howard Marks, the thoughtful leader of Oaktree Capital Management, has called this "the failure of imagination" defining this as "either being unable to conceive of the full range of possible outcomes or not understanding the consequences of the more extreme occurrences" (from his book, The Most Important Thing). This is very important with regard to oil. Most newspapers and financial journals grasp the immediate impact of a falling oil price (or other financial developments) but far fewer seek to understand the second-order consequences (let alone, third, and fourth). When the sub-prime mortgage crisis hit, these succeeding consequences were broadly labeled "contagion". In 2007, everyone knew that the sub-prime crisis would challenge mortgage backed securities and home builders, but very few worried about the health of the banks and financial system. Similarly, last year everyone understood China to be slowing-- and that China and the US were the responsible for nearly all of global GDP "growth" - but somehow a slowing China did not get factored into predictions about the direction of oil prices.
This is a challenge to which we at HBA are not immune. So as to reduce the full failure of imagination (to what we hope will only be a partial failure) we have been giving thoughtful consideration to the higher-order consequences of the falling oil price, which we will share in our next commentary. Stay tuned.
We have spent some time thinking about the things which are unknowable. But we feel strongly that there is something which is knowable. Our time is a historic time. For example, in 1751, Henry Pelham, chancellor of the exchequer, embraced the "consequences of peace" by borrowing at 3% in perpetuity. 264 years later, these British consols still trade. Now George Osborne, Pelham's distant clerical descendant, has made clear his intention of updating those ancient promises, into modern ones. Current rates on the UK 30 year gilts (bonds) are priced to yield 2.67%, so Osborne will likely meet with success in re-casting these perpetual debts at rates even lower than 3%. Future historians will marvel at the 'promises' we have accustomed ourselves to accept. Back in 1751, the British pound sterling was as good as gold. Today, like all major currencies, it is backed by no more than pixels. We have been promised an economic recovery for over 6 years, which has failed to materialize. Ever hopeful, we are again promised that this year is the year for a breakout recovery. More interestingly we also accepted these promises on the faith that rising asset prices create wealth. Before this time in man's evolution, it was quite thoroughly known to be the opposite. That is, it was clear to anyone who paid it even a minimum of thought that wealth creation results in higher asset prices. But now mankind has progressed. We have it on the greatest authority in the land that rising asset prices- a higher stock market and higher real estate prices- create a virtuous cycle- a "wealth effect" of higher spending as people feel the warm glow of euphoric CNBC pronouncements and spend more money. Thus is wealth "created".
The more we think about it, the more certain we are of our prediction: Those yet-to-be-born historians will stare, slack-jawed, at our prodigious gullibility.
Our Prediction - Be Proud, You Are Making History!
| January 15, 2015