The Fallacies of Forecasting

The Fallacies of Forecasting

Economists have rather unceremoniously struggled with their forecasts.

But can you really blame them?

And in yet another rather dull revelation: economists have really struggled the past two years or so. Their forecasts have been all over the place, requiring constant revisions and almost never adequately hitting the mark. Truly, of all certainties, is this one: in future, we shall look back on the year 2020, the two years following it and the period yet to come as one of the grandest failures of economic forecasting ever.

The Chastening

Having endured one of the world’s most historic recorded market crashes, the global economy also saw one of the most robust recoveries it had seen in a while – V- and U-shaped recoveries were all the rage back then. What turned out was “a post-COVID boom with a 27 percent increase in S&P500’s equity valuations. The Fed funds rate fluctuated around zero, reducing the costs of borrowing, and the massive growth led to increased spending across industries,” wrote consulting giant AT Kearney in a note in December.

Come end-2022, and the situation turned rather grim: “the Federal Reserve’s major interest rate (the Fed funds rate) has increased significantly, and the conflict-fed inflation genie has yet to be put back in the bottle. The slowing economy and continued inflation foreshadow a difficult profitability environment for 2023.”

What stands out in this, of course, is how far off economists’ consensus forecasts were in predicting this earlier.

In a piece written in November for the Financial Times, Mohammed El-Erian, president of Queen’s College, Cambridge, outlined rather eloquently the risks of going by consensus forecasts, especially after the ‘chastening delivered by last year’s transitory inflation call.’ Truly, if we dial our heads back to early-2021, almost all major organisations saw the initial spurring of high inflation as transitory in nature – and expected it to pass soon. Barring a few exceptional forecasters (such as the German Rabobank), all got it wrong, of course.

The inflation turned out to be sticky, not only hitting thirty and forty-year highs in certain developed economies, but affecting emerging economies adversely as well. Additionally, given how important inflation forecasts are in forecasting all other economic variables, most other forecasts turned out to be far off the mark as well.

The Big Squeeze

In spite of this, It would also be prudent to remember, of course, that forecasting this period has in no way been an easy task either. As the economy continues to cool, most firms will face a slowdown in growth rates and revenues even while inflation continues to push costs up. Some of the major factors affecting this squeeze on margins are outlined below.

  • Slowing economic growth: Given that many central banks are yet to hit their expected terminal interest rates, growth is set to be constrained for the coming period. Additionally, although inflation has slowed slightly, it very much still persists. The focus for firms will be bottom-line profitability. Margin protection against further rate hikes will be crucial.
  • Keep an eye on the USD: King Dollar is not set to give up his eagle-headed throne any time soon. Buoyed by its safe-haven status, it is set to stay strong over the coming year, especially with recession fears right around the corner. This turbulence is also affecting the labour markets.
  • Deglobalisation and supply constraints: The world is set to get a little more fragmented. Global geopolitics are adversely affecting supply chains and global workforce strategies. Although slightly improved, supply chains still remain a major risk. Insourcing and nearshoring have grown; supply risk will need to be actively managed.
  • Talent Shortage: AT Kearney sums it up: “competition for talent continues to grow. The right workforce needs to be safeguarded to meet strategic business goals.”

[Read the full Financial Times article: ‘The consensus forecast on recession risks complacency’ – Mohammed El-Erian]

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