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'100% chance of recession'? ... the risks of making investment forecasts

 
Ian Kelly
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German DAX At New Low
A trader looks on as the stock market falls. (Source: Getty)

The future is impossible to predict. Okay, there may be a certain irony here in that regular visitors to our blog, The Value Perspective, can be fairly certain they will read a line like that from us every month or so.

Yet the only reason we keep saying it is because all sorts of experts – be it in the fields of finance or sport, weather or politics or whatever – insist on making predictions about the future.

Which. Is. Impossible. To. Predict.

The future is impossible to predict

Still, if there is one thing worse than making forecasts about an unforecastable future, it is making forecasts with 100 per cent certainty.

This is not so much a question of being any more right or more wrong but, quite simply, you could end up looking very silly – particularly if you make your 100 per cent certain forecast over a relatively short period of time.

After all, if you are wrong, some smart Alec is just bound to point that out.

On a not entirely unconnected note, we recently came across an article based on a Bloomberg TV interview in which high-profile investor Jim Rogers stated there was a 100 per cent probability the US economy would be in recession within the next 12 months. As it happens, George Soros’s former business partner made that call in March 2016 so, even with an extra eight months’ leeway on his 12, well … here we are.

Charts of doom?

Take a look at the following two charts.

One may look deeply volatile and scary and the other smooth and reassuring but they actually both represent the same information.

The chart at the top shows how US gross domestic product (GDP) numbers have bounced around since the end of the second world war while the chart on the bottom shows the cumulative effect of that – the actual nominal growth of the US economy in that time.

US GDP since the second world war

Source: Bloomberg 14 November 2017. GDP US dollars 01 Jan 1947 - 14 Nov 2017.

US culmulative GDP since the seond world war

Source: Bloomberg 14 November 2017. GNP US Dollars 01 Jan 1947 - 14 Nov 2017.

In short, GDP fluctuates – sometimes quite wildly – but that does not mean we are heading for disaster tomorrow (or, equally, that we are not heading for disaster).

Nor, of course, are we suggesting the US will never be in a recession again – with the technical definition of a recession being two consecutive quarters of negative growth, it might even be in the beginnings of one right now. It is just that nobody knows for sure.

And the big danger in all this is that, once you start confidently making predictions, you may start confidently investing on the basis of them, which can be a dangerous road to travel.

Back in March last year, Rogers told Bloomberg that, in light of the economic turmoil he envisioned, he had gone long the US dollar and could even see a bubble developing in the currency.

“I mean, if markets around the world are crashing – let's just say that scenario happens – everybody’s going to put their money in the US dollar,” he said. “It could turn into a bubble.”

Again, maybe that will happen at some point but, then again, it may not.

So, rather than believing you can know everything about the world as an investor, surely it makes more sense to factor a range of scenarios into your thinking.

Factor in a range of scenarios

That way, while you may be hoping for the best, you are at least prepared for the worst.

On The Value Perspective, we aim to achieve this by investing in companies with strong balance sheets and cheap valuations.

This should afford them the capacity to weather difficult times and provide a margin of safety that can absorb the impact of adverse developments and protect us from permanent losses of capital.

In effect, this value-oriented approach is a tacit acknowledgement of London Business School professor Elroy Dimson’s wonderful observation that “risk means more things can happen than will happen”.

  • Ian Kelly is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.

Important Information: The views and opinions contained herein are those of Ian Kelly and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

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