What the Smart Money Thinks

Every January, a group of the smartest money minds in my hometown of Chicago gets together for a luncheon sponsored by Free Market, an economic consulting firm that provides data analysis and insights for institutional money managers. The 18 guests are asked to make predictions of the high, low and closing numbers for the Dow, Nasdaq Composite, fed funds rate and 10-year Treasury note.

The competition for the forecasting prize, the Eagle statuette, is fierce. Individual scores for last year's predictions for each of the categories are ranked to the decimal point and adjusted by mean error and standard deviation. Category winners get a tacky, home-made certificate, which I've actually seen displayed in some money managers' offices! In the nearly 20 years of this contest, there have been a lot of ups and downs.

The real bragging rights go to the overall winner, who this year is well-known forecaster Jim Bianco of Arbor Research. I'll share his specific forecasts for the coming year, but perhaps of equal interest is the round-table discussion during which each participant gets a chance to share his or her reasoning for the numbers being submitted to the contest.

What Worries Money Managers

The commentary at the luncheon is as interesting as the numbers. For instance, Free Market Founder Michael T. Lewis raised the issue of how we measure inflation, calling the term "core" inflation, a "tragedy of economics." Core inflation excludes food and energy, and Lewis points out that we need to look at the big picture. It's a mistake to leave out the impact of energy prices, which certainly will move through the economy, he says.

Economist David Hale is a friend of incoming Fed Chairman Ben Bernanke, who certainly isn't making any public predictions. But Hale figures that a slowdown in housing inflation during 2006 will give the Fed some room to drop rates later in 2007. Hale figures higher rates between now and then will slow housing borrowing.

Still, Hale's no housing bear, pointing out that since the depression the U.S. has never had a national decline in housing prices, in spite of drops in individual markets like California in the early 1990s.

I also found it interesting how frequently the participants referred to Iran -- not Iraq -- in terms of its potential impact on the economic outlook. Some factored in a confrontation over Iran's nuclear energy plans. But money manager Sy Lotsoff figures that Congress might give the president authority to take action, which could scare Iran's rulers into negotiation.