The folly of forecasting
“The only function of
economic forecasting is to make astrology look
A CONSIDERABLE NUMBER of current decisions are based on what economists forecast. Whether it’s the SA Reserve Bank setting policy or a housewife grocery shopping, to a certain degree economic forecasts have become part of the decision-making process. That’s even more so for those with investments and still more relevant for those with investment degrees.
But let’s face it: economists get it wrong. In fact, they get it wrong a lot of the time. And when they do get it right they take their time doing so. Renowned late economist John Kenneth Galbraith spared no sympathy when he stated: “The only function of economic forecasting is to make astrology look respectable.”
Paris-based investment bank Société Générale has compiled an index (the Economic Surprise Index) in response to the problem of forecasting folly, as described in the first paragraphs. When the index yields a positive result it means the actual data being released is better than economists had expected. A negative result would mean economists had overestimated the actual data. The results are plotted in the graph attached.
The market normally reacts positively to better than expected data and negatively to data that undershoots expectations – thus either positive surprises or negative surprises. Intuitively, you’d expect the market to perform well when SocGen’s graph is above the x-axis (positive surprises) and you’d like to be out of the market when the line is below (negative surprises). That would have been true if the behaviour of both economists and the market didn’t change – but, as we’ve concluded, they do.