The folly of fore­cast­ing

Finweek English Edition - - COVER STORY - DRIKUS COM­BRINCK,

“The only func­tion of

eco­nomic fore­cast­ing is to make astrology look

re­spectable”

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.

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