Mid-Year Update: Ode to the Rules of Forecasting

Shareowner, Jul/Aug 2004 by Bederman, Earl

My First Rule of Forecasting is this: If you are ever right, never let 'em forget it!

Remember "2004: The Year of Disappointment" - what a call! Are there any equity market investors - other than those who are short the market - who are not feeling the disappointment of unmet expectations, or even worse, significant shrinkage in their equity portfolios after having taken the plunge around the start of the year?

But, we need to know if the original assumptions were sound, and whether or not new factors are coming into play that might influence the unfolding of events over the coming months and quarters.

What Happened

The accompanying table contains a sampling of the key themes that were put forward those many months ago.

All of this brings us to where we now stand.

What's Next

My scenario for 2004 ended on a hopeful note that was predicated on the belief that rising bond yields would prove to be self-corrective. The momentum of the economy would slow, easing investor fears of rising inflation. The market would do better once policymakers refocused their attention on the need to fix the deficit and reverse the dollar's decline. At the time I expressed the view that the market would again be heading higher at the end of 2004.

Rising Rates. Perhaps it would be better to leave well enough alone and stick with a forecast that has been 'bang-on'. I am slightly tempted to do that because I am confident that eventually bond yields will have the intended slowing effect.

Of course, resisting temptation is oftentimes what forecasting is all about. I believe the need to do so has become more compelling because of two important change elements that have injected themselves into the current economic and investment climate.

Surprises

The U.S. Election. At the start of the year, I assumed that Bush had a virtual lock on re-election. I am now decidedly less confident of that outcome.

Simply put, there exists the very real possibility that he could lose. A Kerry victory is something for investors to worry about. Higher taxes and a growing protectionist tilt will be unkind to the equity markets.

Price of oil. The second issue is the skyrocketing price of oil. Notwithstanding the benefits to certain sectors and regions, the real impact is that higher oil prices will function both as a tax on economic growth and a source of wage/cost inflation given the strength of the job market. This is bad economic medicine no matter who is in the Oval office. It will also put the Fed off balance - and inject more uncertainty into the interest rate outlook.

Putting it all together, I see the pieces of a nasty stagflation puzzle being assembled. Bottom line, the return of good times seems more distant. The disappointment phase of this cycle looks to be stretched out into 2005.

This brings me to my second Rule of Forecasting: If you must forecast, then forecast often.

EARL BEDERMAN is PRESIDENT OF INVESTOR ECONOMICS INC., A CONSULTING FIRM SPECIALIZING IN APPLIED RESEARCH IN FINANCIAL SERVICES, ECONOMIC AND MONEY MANAGEMENT