Investor Minute
Economists Reflect on Lessons From a Chaotic Year
When there’s a major earthquake in a coastal region, geologists can predict several things. First, there will very likely be aftershocks in the same location. And second, there’s a good chance of a resulting tsunami.
In both cases they can’t predict how severe these after-effects will be, nor how widespread their consequences. But they know that these phenomena are often likely to follow an earthquake.
On the other hand, the initial tremor itself is completely unpredictable. Even though earth scientists understand much of an earthquake’s underlying causes and have identified locations where they seem most likely to occur, there’s no way of knowing with certainty and sending out a warning before one happens.
Geologists are much better at analyzing and making sense of seismic data after an earthquake.
The same goes for economists. More than two hundred years of studying data has given these money scientists a good understanding of how economies work at the macro level. But, like geologists, economists can’t consistently forecast with precision when disruptive events will occur, nor how severe their aftermath will be.
Olga Bitel is a global strategist and Hugh Scott-Gall is a portfolio manager and co-director of research at William Blair Funds. Both are trained economists, and both were brave enough to assess the accuracy of their previous forecasts for 2022 at the end of the year.
Keep in mind that they had been trying to predict economic conditions at a very broad level, not stock market performance—let alone picking individual winners and losers.
Bitel says that their prediction of slowing growth had been on track, but other factors, such as inflation, were more severe than they had expected.
“Inflation was so strong not the least because it was exacerbated by geopolitical tension,” writes Bitel. The suddenness of the Russian invasion of Ukraine created a psychological “inflationary impulse.” Then, when the conflict forced Europe to find new sources of oil and gas at 2-3 times what it had been paying, global inflation took hold for real.
This, in turn, led to another event not generally predicted by economists: the aggressive rate at which the Federal Reserve raised interest rates. Bitel and Scott-Gall were expecting the Fed to gradually increase rates until they reached the so-called neutral rate (the nominal rate minus inflation). But they were not thinking it would happen in a six-month window nor with consecutive 75-basis-point hikes.
Once they saw the Fed’s actions, they were expecting a significant “credit event,” an aftershock caused by tightening credit. However, they can’t say with any certainty if this was the crypto collapse, the balance-of-payment difficulties in some emerging economies, or whether this event is yet to happen.
Even when looking at the global economy in general, and identifying the factors that are likely to come into play, it’s still difficult to predict what will actually take place.
As Scott-Gall explains, “Some major events happened that very few people expected. Others were more foreseeable, but they might not have played out exactly as forecast.”
The prudent investor won’t be discouraged by this stubborn unpredictability but will rather accept it as a fact. Instead of trying to time the market or pick winners, he or she will take a diverse approach with a long-term goal, and stick with the unique plan developed by their trusted advisor. Protect your portfolio from volatile markets. I have some ideas for you. Click here to schedule a free call with me.