Thursday, July 25, 2013
Roumell Q2 2013 Letter: Price Trumps Economic Forecasting
Price Trumps Economic Forecasting
In July 2009, the very popular macroeconomic investment strategist Marc Faber predicted that the United States was about to enter a period of hyperinflation approaching the levels of Zimbabwe. PIMCO’s Bill Gross in May of 2009 expressed his belief in “accelerating inflation” and low market returns because of subdued growth. Inflation has been modest, at best. Nouriel Roubini, the widely regarded NYU economist who correctly predicted the housing collapse, rightly indicated in 2009 that the economic recovery would be anemic; unfortunately for those who may have taken his advice, he recommended investors keep all their assets safely in cash, thereby missing the past few years’ dramatic market rise. Columbia University Professor Edmund Phelps, winner of a Nobel Prize in economics in 2006, predicted in 2009 that it may take as long as 15 years for U.S. households to restore the wealth lost in the financial crisis. It actually took four years, having recently climbed to $70 trillion, above the 2008 peak of $67 trillion.
There’s no shortage of examples of “the dismal science’s” dismal record in predicting the economy’s future. In July 2005, the same month that home-builder stocks peaked, soon-to-be Federal Reserve chairman Ben Bernanke disputed the existence of a housing bubble. Bernanke said, “We’ve never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize.… I don’t think it’s going to drive the economy too far from its full employment path, though.” A few months later, his predecessor, Alan Greenspan, said, “We’re not about to go into a situation where prices will go down.… There is no evidence home prices are going to collapse.” Moreover, macroeconomic conditions do not foretell market responses, as Roubini’s correct economic forecast, but dead wrong market prediction, well illustrates. If the best trained, most highly educated economists, possessing the best information, cannot reasonably predict the future or, more importantly, markets’ reactions, why do investors keep trying to use economics as an investment tool?
Readers of our letters know that we have weighed in over the past few years with our own economic observations. Like many investors, we have wrestled with how much time we should allocate to understanding macroeconomic trends. We have noted—as points of concern—economic growth rates that seem to be perennially reset down, in both the United States and Europe, persistently high real unemployment levels, and overleveraged consumers. Particularly in the aftermath of the financial crisis, we focused more time on these issues. However, three factors appear to undermine the utility of economic forecasting as an investment tool: the absence of price in the equation, the scarcity of original thinking, and the difficulty of predicting human behavior.