Forecasting the Economy

Is it possible for any investor or money manager to consistently forecast the economy or the market?  Those who attempt to forecast the economy in attempts to do better at investing are referred to as active investors or active money managers.

The greatest challenge for any active investor or money manager is the extreme difficulty in forecasting the economy or accurately predicting the market’s direction in advance.  This makes it hard for them to anticipate bear and bull markets.  In fact, The New York Times said that Wall Street has failed to predict a single recession in the last 30 years.

Looking back on the forecasts made for the markets at the beginning of 2008, many of them turned out to be quite optimistic.  At the end of 2007, News Day gathered market predictions from “eight major Wall Street Securities firms” and found an average price target for the S&P 500 by year-end 2008 of 1,653, representing a 12% increase over 2007.  And at the beginning of 2008, USA Today similarly surveyed nine Wall Street investment strategists.  They were a little less optimistic, expecting an average price target for the S&P 500 for the year of 1606, only an 8.6% increase.  Of course, we now know that the S&P 500 Index declined by 37% in 2008.

If Wall Street experts can’t even predict recessions or the direction of the market, it is questionable how active managers can successfully pick individual stocks, in bear markets or bull markets, especially since a stock’s performance is often very sensitive to economic and market conditions.  

Standard and Poor’s has been measuring the performance of active managers against their index counterparts for several years now.  Their May 2009 Indices Versus Active Funds Study specifically focuses on the bear market of 2008 and concludes that “the belief that bear markets favor active management is a myth.