A bubble is a product of feedback from positive price changes that create a ‘new era’ ambiance in which people think increasingly that prices will go up forever…Today’s bond market…is just the opposite of a new-era ambiance. Instead, the demand for bonds is driven by an underlying angst about the slow recovery and pessimism of the future…that’s not a bubble.” Robert Shiller
Over the past several years I used my newsletter to voice my concerns regarding the macro-economic landscape, while attempting to provide practical solutions for investors. Since my venture into financial commentary a decade ago, I have questioned the veracity of consensus opinion and noted how it tends to be wrong, especially in regard to interest rates. Of equal importance are the factors that cause a consensus to form and whether they are benign. In essence, I have questioned whether the consensus is truly formed through an amalgamation of individuals conducting impartial and empirical analysis, or whether these calls are simply a function of herd mentality or self-interest at work.
Many observers have an intuitive sense that economists and analysts kind of trip over themselves attempting to be part of a consensus. The rationale for this behavior may be defined as a personal risk management exercise for some knowing that going against the system has little personal upside potential.
Laurence J. Peter of “Peter Principle” fame suggests, “An economist, is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today.” Many economists and analysts are very bright academics who do an excellent job, many others however, lack what I refer to as an “empirical intuitiveness.” I believe the use of evidence-based data is made stronger by instinctual or visceral capabilities. Forecasting may be more art than science. To paraphrase the economist Gary Shilling, consensus thinking is fully discounted in the market place thus, offers very little value.
In an article entitled Economic Forecasting: “History and Procedures” John Hawkins suggests “economists tend to be better at predicting macroeconomic variables such as inflation and GDP than financial variables such as market rates and prices. They also have significant difficulties with large turning points.” To illustrate this broad point, researchers at the University of Alabama did an analysis of Alan Greenspan’s forecasts (of long-term treasuries) as a Wall Street Journal contributing economist versus the consensus economists. The period in question took place during the early 1980s and covered eleven forecast periods. “In the eleven forecast periods, Greenspan’s forecast was more accurate than the consensus five times, less accurate on five occasions, and roughly equivalent to the consensus once. Interestingly, out of the eleven forecasts the consensus forecast was wrong in predicting the direction of the future yield changes nine times.” In any case, negative investment consequences of incorrect consensus forecasts on the investment public are substantial; investors and their advisors deserve better.
I believe there is ample reason that the street gives little credibility whatsoever to the concept of falling rates. One can make the argument that it is not in the interest of the street to project falling interest rates. Falling interest rates imply stagnating or falling growth. Declining growth cannot support an equity market where fundamentals are largely divorced from historic norms. As I try to understand the interest rate consensus, I believe this theory has some traction. While I am not entrenched contrarians, my pragmatic approach to investing causes me to be skeptical of consensus thought. There is comfort found in following consensus opinion, though this solace provides little opportunity to discover value. Agreeing with market consensus leads to market returns at best and over time lost opportunities.
My team put the data below together back in 2014 to examine the Survey of Professional Forecasters produced by the Philadelphia Federal Reserve Bank. As one can see not only were most surveys of the professionals wrong they were wrong by percentage points. One has to wonder if you get the direction wrong on rates not just the magnitude of a move why compensation follows? In addition, since the Global Financial Crisis, inflation has been guided upwards two to three years out in almost every survey.
The reader may be well aware that our friends at the Fed suffer from a similar affliction as street economists and analysts. Since 2008 the Fed has been too optimistic adding on average 1.2% non-existent growth annually to their forecasts. The further they forecast into the future the worse the data becomes. The investing public needs to think for themselves and or align themselves with those that have demonstrated insight and independence over time.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.