Even in normal times, most of us would like to know what is likely to happen this year and next in the economy and the markets. But in the heat of a crisis, when property values head south, unemployment spikes and retirement investment accounts get skewered, that need takes on new and more "interesting" forms.
The irony, of course, is that just as interest in predictability becomes most acute, the volatility of the environment makes accurate forecasting even more difficult. We may lampoon economists and market strategists for their lack of consensus, or, when that is somehow exceptionally forged, we may lament its accuracy. Still, we want to know what the forecasters think. They've been pondering their subject more closely than most. The trick is in how we reference their thoughts and model outputs, without being slaves to their numbers.
In today's climate what is paramount in people's minds is the issue of the turnaround, or the bottom in economic activity. Is it in 2009, or 2010, or even beyond? Will it be U-shaped or V-shaped or L-shaped? How low will corporate profits go, and when will they start turning upward? Will the equity and credit markets anticipate those moves correctly, or will they lag behind and merely follow?
In short, when are things going to get better?
The argument here is that many different viewpoints exist on these questions. "Consensus" is really just an average of those views. And while some economists are better at mobilizing the facts, make more compelling arguments, and should be listened to more closely, there is often as much or more insight to be gained from the trends or changes in so-called consensus views as there is in any one single-shot output from any particular model.
In terms of gross domestic product (GDP) estimates - the most conventional measure of economic output - market economists' views are currently averaging to a flat vision for the world in 2009, with a 1.5-per-cent contraction in the U.S. economy. The International Monetary Fund's latest modelling effort is similar, predicting growth of 0.5 per cent in 2009 and 3 per cent for 2010, on a global basis. In the developed markets, the numbers are worse, with the economy shrinking by 2 per cent in 2009, and growing by 1.1 per cent in 2010, with the emerging market economies taking up some of the slack, since the IMF sees them growing at 3.3 per cent in 2009 and 5 per cent in 2010. Goldman Sachs, which developed the most accurate Wall Street prediction of the 2008 recession, has arrived at similar estimates - putting global growth at 0.2 per cent in 2009, with a rebound to 3.1 per cent in 2010. Also similar to the IMF view, Goldman expects the U.S. economy to contract by 1.6 per cent in 2009, with growth of 1.2 per cent in 2010 - an anemic version of "rebound" relative to past experiences of postrecessionary times, and less optimistic than the average of Wall Street forecasters.
As to the trajectory of company earnings prospects, and potential recovery in stock markets, estimates from Wall Street analysts and economists indicate they expect earnings in 2009 to shrink, with a large rebound in profitability in 2010. Merrill Lynch, Bank of America, for example, is calling for a massive decline in profitability for 2009. It forecasts a 16-per-cent drop in operating earnings for the broad-based U.S. companies index, after an already terrible 2008, further noting that its scenario implies an unprecedented three-year decline that will see earnings cut by half. After that decline, however, it forecasts a 21-per-cent growth in earnings for 2010 and foresees the stock market beginning to rebound with or ahead of that turnaround. A look at the table above, which looks at how the U.S. stock market has done during previous crises, suggests that economic recovery and earnings rebounds are usually accompanied by moderately strong recoveries in the stock markets as well. But it also highlights that this recession is different, in that it looks like it will last longer than average, and has already seen a deeper decline in market fortunes.
So, are these forecasters right?
What should we think of their fundamental predictions? Are we really getting positioned for a reasonable recovery in 2010, more or less in step with previous recessions, and different from what was experienced in the early 1930s?
Previous studies of such forecasts show that while they sometimes get it right, they frequently miss, sometimes markedly so. The systems they seek to predict have too many causes and variables to be accurate most of the time. (This complexity is readily captured in Bank of Canada Governor Mark Carney's recent statements to the House of Commons finance committee, indicating that the central bank draws on no fewer than 21 models when seeking to forecast future outcomes in the Canadian economy, with four of those being more fundamental than others.) This is not to say models cannot be directionally correct, for they often are. But some forecasters are more biased than others. Sell-side analysts are often too optimistic; some cleave to house views handed down from above. They may have an incentive to adopt a given position simply for the sake of standing out from the crowd. Or, as often occurs, they may tend to extrapolate unduly from what has happened in recent times - according too little weight to new factors in the "problem set."