effort. It is usually part of a so-called top-down investment process that
starts with an outlook for the economy and monetary conditions, continues to
the strongest industries, follows with detailed company study for stock selection,
and may include an overlay of technical analysis to provide a timing dimension.
Some would add analysis of social and political conditions even before economic
studies.
Economic forecasts derive from models—usually of the aggregate national
or global economy, but sometimes of parts of those economies: particular industrial
sectors, regions of the world, or even single products or firms. Basic approaches
to forecasting simply extrapolate the past; more sophisticated models
attempt to understand the sources of past changes and build them into their
forecasts. The latter requires knowledge of economic history and economic principles,
though, even then, forecasting is by no means an exact science. But while
the accuracy of economists’ predictions is frequently a target of jokes, forecasting
remains a popular pursuit.
Forecasts for the macroeconomy are published regularly by academic
institutions, thinktanks, governments, central banks and international organizations
like the OECD [Organization for Economic Cooperation and Development]
and the IMF [International Monetary Fund]. In these places, modeling
can, to a certain extent, be conducted free of the constraint of producing quick
and usable data on a daily basis. But in the investment world, forecasts are required
to be done early and often. A relatively short-term outlook is normally the
limit of investors’ aspirations—what will happen to interest rates within the next
month?—with decision makers demanding rapid output that they hope will be
directly relevant to their immediate problems.
Much of the output of financial market models is naturally closely guarded
in the hope that it may bring advantage to its owners and their clients. But, at
the same time, investment economists like to maintain a public profile for marketing
purposes and are often called on by the media to give their opinion on the
latest macroeconomic developments. Their interpretations of economic data
may give some clues as to how the financial markets will react, though more
often than not, they are explaining why the markets have already reacted as they
did. Invariably, too, there are disagreements about what various indicators mean,
depending on different beliefs about the economy and whether the firm is taking
an optimistic or pessimistic view of the markets.
Each month, the Economist polls a group of financial forecasters and calculates
the average of their predictions for real gross domestic product (GDP)
growth, consumer price inflation, and current account balances in a variety of
countries. More specialized services like Consensus Economics survey over three
hundred economists each month and offer details on average private sector
predictions.
Economic Forecasting Guru: Peter Bernstein
Despite the pressures for early and often forecasts, a number of Wall Street and
City economists do as good a job as any forecasters, among them Abby Joseph
Cohen, Stephen Roach, and Edward Hyman. Most such investment economists
are good students of market conditions—careful keepers of useful data—and on
occasion creative in extracting some kind of signal out of the noise. Ed Yardeni,
for example, the chief economist at Deutsche Bank, turns his website into a
cyber-chart room. If you want to access data and view charts, Yardeni’s site is an
essential stop. He also makes his commentary available in a section for clients
that is password protected, but a substantial amount of the content is openly
accessible.
One economic commentator stands amid the few that many of us would
class as the best: Peter Bernstein. He grew up heading his father’s investment firm,
Bernstein MacCauley, in New York. He was the first editor of the Journal of Portfolio
Management, founded by Gilbert Kaplan, and has received many awards,
among them the highest honor granted by the Association for Investment Management
& Research, the investment management industry’s professional body.
Bernstein is able to walk on both streets—with practitioners and academics.
He writes a newsletter, Economics and Portfolio Strategy, to test and disseminate
his analyses. And writing is one of his main strengths: His two books
on the history of risk and on how capital ideas came to Wall Street were regulars
on the business best-seller lists during the 1990s.
Like a good academic, Bernstein marshals all the arguments, especially
those that are counter to his own position. His mid-February 1998 letter, for example,
examined the case for exuberant stock prices in the United States, giving
particular emphasis to the market’s reliance upon an all-knowing Federal Reserve
for economic management. Bernstein concluded that “stocks are a risky investment
and should be managed accordingly.” Since that analysis was approximately
the same as his November 1997 conclusion, he was ahead of the wave
and for the right reasons. Bernstein is also faster than most to admit where he has
been wrong and to try to examine what led him astray—or, as he jokes, “what
led the market astray when it failed to act the way I thought it would.”
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