Of Forecasts and Windage

An accomplished marksmen learns to adjust for windage, the influence of the wind in deflecting the course of a bullet. Statistical forecasting contains an element of windage. One must adjust for the pontifications of windbag pundits and politicians, buffeting generated by the movement of herds, and data adjustments for trends, seasonal patterns, and other deviations. Often forecasters are influenced by recent experiences (recency bias), a human trait reflected in a comment attributed to Woody Allen: “I have seen the future. It is very much like the present, only longer.”

A recurring theme is “the new normal,” a continued slow growth pattern. Estimates of U.S. GDP growth remain tepid, in the two-percent range. A Federal Reserve Bank of Philadelphia survey of economists showed forecasts in a tight clump around an average of 2.3% for 2013. Writer Justin Lahart urged caution in embracing consensus statistics, noting that another Fed survey showed that in 23 years of GDP forecasts ending in 2005, median forecasts were off by at least a full percentage point half the time. (The Wall Street Journal, 1/26/13)

Given that nugget, we might surmise fifty percent odds that GDP for 2013 could range from 1.3% to 3.3%. Speaking to financial planners in Atlanta, GA, on 1/24/13, Emin Hajiyev, assistant director of the Economic Forecasting Center at Georgia State University, sees “a growth pause in the cards,” with growth on the lower side of the consensus forecast. “We have a bifurcated economy: somewhat upbeat consumers but a very subdued corporate sector. The debt ceiling rancor doesn’t help.” Kiplinger sees GDP growth for 2013 about the same as 2012—2%.

Mr. Hajiyev asked, “Is 3.5% real GDP growth possible in 2014?” “Yes, if we make our down payment on the deficit, the European Central Bank’s bond buying and the U.S. Fed’s attempts work as intended, oil stays at about $90 a barrel, and the Germans write off Greek debt and replenish Spanish banks smilingly.”  How’s it coming? Currently Mr. Market sees trends as friends. Auto sales and residential construction indicators have been positive, albeit with a ways to go to eclipse the pre-crash peaks.

Labor market data points to recovery but we need more quality jobs. There are too many low paying jobs. The Affordable Care Act is prompting firms and institutions to move people to part time status to avoid health insurance mandates.  In Europe, banks are repaying loans from the ECB early, indicating progress in diffusing the euro zone crisis.  Business has pulled back midst uncertainty. Investment in tech equipment and software has slowed; durable goods orders are flat-to-down. Big corporate CEOs are concerned about government deficits and increasingly expensive regulations.  

Oil prices have moved up since mid-November, reaching $95.88 on January 25, 2013. Oil over $100 a barrel will not aid GDP growth, however, Mr. Hajiyev expects prices to stay below $100 barring emergencies.  He echoed concerns raised by ace bond manager Bill Gross of PIMCO over management of U.S. debt. Said Gross, “Studies by the CBO, IMF and BIS (Bank for International Settlements)...suggest that we need to cut spending or raise taxes by 11% of GDP over the next 5 to 10 years. Unless we close this gap...our debt to GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow, and the dollar would inevitably decline.”  

Equity investors have been in a bullish mood ever since we dodged the fiscal cliff bullet. After a run up, a pullback is always possible, but money is flowing from safe assets to stocks. The 10-year Treasury note rate at 1.947% on 1/25/13 is flirting with 2%. The threat to fixed income assets and consumer and investor real incomes is encapsulated in Bill Gross’ observation. Inflation is the ultimate tax, and a favored tool of spendthrift politicians. Keep your eye on the debt and budget talks. Adjusting for windage in your investment policy may be called for.