Life is chock-full of twists and turns, unexpected detours, and completely unforeseen circumstances. It keeps things interesting.
The financial markets and the economy are no different.
I’m often amazed at how much people rely on forecasters and pundits to form their opinions on the future direction of the stock market or the economy. I sometimes wonder if they understand how abysmally bad those “talking heads” are at accurately predicting the future.
Don’t take my word for it, though. Allow me to provide two concrete examples.
As the year 2007 came to a close, the economy was already looking shaky. Earnings reports from U.S. companies were underwhelming at best, and downright alarming at worst. The housing market was already stumbling. Many economists were calling for a recession in 2008.
It wasn’t a secret that the next 12 months could be rocky.
Every year, the big Wall Street firms publish predictions about the level at which the U.S. stock market will end the year. The Wall Street analysts who make those forecasts generally despise the process, knowing good and well that it’s an impossible feat. But their Wall Street bank employers demand it because their customers expect it. Everyone loves a crystal ball, even the cloudy, cracked, and discredited ones.
The S&P 500, a collection of the biggest and most well-known U.S. companies, ended 2007 at 1,468. The Wall Street analysts reviewed the latest economic data, sharpened their pencils, and put their metaphorical wet fingers in the air to divine the future. As they trotted out their predictions at the end of 2007, it became clear that despite the economic turmoil, analysts – the most connected, rational, and learned market watchers – figured the market would be okay in 2008.
The most bullish forecast by the analysts had the market hitting 1,680 by year-end. The most pessimistic was 1,520, which meant an increase of 3.5%.
How wrong they were. When the year ended on December 31, 2008, the S&P 500 was like a washed-up prize fighter, wobbling and staggering on the ropes. The market closed at 903.
How about a more recent example?
In 2022, the Federal Reserve realized they had reacted too late to incoming economic data. The economy was zooming. Inflation was heating up. And companies couldn’t hire employees fast enough. In reaction, the Fed began raising interest rates, hoping to slow the economy without yanking the emergency brake.
That’s no easy feat. In fact, hardly anyone thought it could be done.
Bloomberg, the financial data and media powerhouse, consulted their whizbang economic models that were used to calculate how our complex economy would fare in 2022. The models pumped out a clear prediction: 100% odds of a recession by October 2023.
It wasn’t just the computers that saw gathering storm clouds on the horizon. Former Treasury Secretary Larry Summers said in 2022 that bringing inflation down would require an unemployment rate of above 5% for years. There was no other way to tame inflation – it must come at the expense of workers.
The computers and Summers were wrong. The U.S. did not experience a recession in 2023 – or in 2024 for that matter, up to this point anyway. The worst unemployment rate since then has been 4.3%. Yet, inflation has fallen back to more normal levels, nearing the Fed’s target of 2% per year.
Daniel Kahneman was a brilliant psychologist who spent his life researching why people behave the way they do. He was once asked why forecasters have such a hard time making accurate predictions. Here’s what he said: “…the world is difficult to anticipate. That’s the correct lesson to learn from surprises. That the world is surprising.”
The world is surprising. We shouldn’t be surprised by that. But we routinely are.
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