Dan Kemp: As investors, we are continually bombarded by economic forecasts, from globally respected bodies such as the IMF to fund management group and even our friends and family.
These forecasts are generally designed to influence our opinion and can even drive our decisions. It is therefore worth considering the value of these forecasts and how we can use them to make better investment decisions. In doing so, we would do well to remember the Danish proverb “It is very hard to predict, especially the future.”
This reminds us that the future is unknown and therefore probabilistic. Nothing can be predicted with 100% certainty over a specific timespan (even death and taxes can normally be delayed) and so it is essential to understand the degree of confidence the forecaster has in their predictions. A prediction made with a 60% probability is likely to be wrong almost half the time and is therefore of little use to an investor making a single decision based on that prediction. Any forecaster worth their salt should be able to provide a probability level with the predictions they make, those that don’t should be treated with great scepticism.
Second, it is important to remember that the stock market is not the same as the economy. Most stock markets are dominated by companies that are global in nature. For example, the largest companies listed on the UK market derive approximately 70% of their sales from outside the UK. Consequently, the ever-growing tide of economic forecasts related to Brexit, are likely to have limited relevance for these companies or consequently for investors.
That is why the team at Morningstar Investment Management try to avoid such forecasts, preferring as our guide, the long term expected return that is embedded in the price of an asset. This helps us understand whether the current price represents an attractive opportunity or a perilous trap and makes us less reliant on a crystal ball.
