"Consensus is what many people say in chorus but do not believe as individuals."
-- Abba Eban (Israeli foreign minister from 1966 to 1974)
In an excellent essay published a year ago,
of the consistent weakness embodied in consensus forecasts. As he puts it, "economists can't forecast for toffee."
Attempting to invest on the back of economic forecasts is an exercise in extreme folly, even in normal times. Economists are probably the one group who make astrologers look like professionals when it comes to telling the future. Even a cursory glance at Montier's Exhibit No. 4 (above) reveals that economists are simply useless when it comes to forecasting:
They have missed every recession in the last four decades. And it isn't just growth that economists can't forecast; it's also inflation, bond yields, unemployment, stock market price targets and pretty much everything else.... If we add greater uncertainty, as reflected by the distribution of the new normal, to the mix, then the difficulty of investing based upon economic forecasts is likely to be squared!
-- James Montier
How Did Consensus Do in 2011?
As we entered 2011, consensus estimates for economic growth, corporate profits, stock price targets and interest rates were generally optimistic and, as is typical, grouped in an extraordinarily tight range. Last year, I chose to use
(GS - Get Report)
forecasts as a proxy for the consensus. Here were Goldman's forecasts for 2011, with the likely or actual 2011 full-year returns/results in parentheses:
- 2011 U.S. real GDP up 3.4% (up 1.8% actual), and global GDP up 4.7% (up 3.8% actual);
- 2011 S&P 500 operating profits of $94 a share ($97 a share actual);
- year-end S&P 500 price target at 1450 (Friday, Dec. 23's close: 1265 actual);
- 2011 inflation (core CPI) of +0.5% (+1.7% actual); and
- 2011 closing yield on the U.S.10-year Treasury note at 3.75% (2.03% actual).
How Did My Surprise List for 2011 Fare?
"Those who cannot remember the past are condemned to repeat it."
-- George Santayana
My surprises for 2011 attacked some of the closely grouped and nearly universally optimistic consensus expectations on the part of money managers, strategists, economists and members of the fourth estate. My intention was not to be a Cassandra or to be a contrarian for contrary's sake but rather to recognize that most prefer the dreams of the future to the history of the past. My surprises embodied an often repeated lesson of history: What seems easy for (bullish) investors to imagine today might prove more difficult to deliver, as prospect is often better than possession.
Looking at history, there was no better example of misplaced optimism than in the period leading up to the Great Decession of 2008-2009, providing a vivid reminder of the poor forecasting ability and investment risks associated with the crowd's baseline expectations and the value of a surprise list that deviates from that consensus.
Three years ago, only the remnants anticipated anything near the magnitude of the fall in the world's economies and capital markets, despite what appeared to be clear and accumulating evidence of economic uncertainty and growing credit risks (and abuses). The analysis of multi-decade charts and economic series convinced most (along with other conclusions) that home prices were incapable of ever dropping, that derivatives and no-/low-document mortgage loans were safe, that there was no level of leverage (institutional and individual) too high and that rating agencies were responsible in their analysis. Importantly, they also failed to see the signposts of an imminent deterioration in business and consumer confidence that was to result in the deepest economic and credit crisis since the early 1930s.