Dear Clients and Friends,
At the beginning of every year there are hundreds, if not thousands, of market commentaries about what should be expected from both the economy and our markets for the new year. Most investment companies will have forecasts for the expected returns of the market for the new year, and this tends to make good press. My goal is not to discredit my own industry, but rather I would like to put these forecasts and predictions in their proper context. Hopefully this will allow the investor to have greater insight into why they are used and how useful they may, or may not be, in decision making.
With something that is richly complex like the market or economy, anyone trying to map out predictions based on a model will find it next to impossible to repeatably do so with accuracy and precision. The billions of interactions that occur in a large economy are distilled down to simple numbers like GDP, CPI etc. But the interactions themselves have various ‘knock-on’ effects that are almost impossible to model. Take for example a simple football game. We can see on paper which team has a statistical advantage which allows for a model to predict an outcome. However, if in the first quarter of the game the star quarterback is sidelined with an injury, there are multiple variables that have now changed. The star QB being one variable that then effects the running back, the momentum, the offensive scheme, and so on. These ripple, or knock-on effects, will have an impact and are next to impossible to predict.
Over 2600 years ago a Chinese Poet named Lao Tzu wrote, “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge”. In science, as in economics, predicting outcomes is fraught with problems. Niels Bohr once quipped, “Prediction is very difficult, especially if it’s about the future”. The problem with predicting the future by using the past is the variables that were meaningful in the past might not be meaningful in the future. Economists use variable that are largely based upon past behavior to gain future insight, but what if those variables change?
We have to look at economic models as tools. Using economic models and predictions to map out the economy can be useful. These models show how government policy or Fed policy might affect different aspects of the economy. This is useful, and it should be used to help guide policy makers and business to aid in budgeting and planning for the future. George Box, one the most celebrated statisticians of the 20th century once noted, “Remember that all models are wrong; the practical question is how wrong do they have to be to not be useful.” Using economic models and predictions to invest one’s money is the wrong use for almost every model.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All investing involves risks including loss of principal. No strategy assures success or protects against losses.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.