The Independent Market Observer

1/7/14 – Working on the 2014 Outlook

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jan 7, 2014 8:05:27 AM

and tagged Outlook 2014, Commentary

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Every year, I struggle with the notion of preparing an outlook—I won’t use the term forecast—for the following year. Every year, I point out, to no avail, that it would be much better to do a forecast for the previous year: better data, much more context, and certainly greater accuracy. I’ve had no more success this year than usual, so I’m preparing my outlook as you read this.

The reason I call it an outlook, rather than a forecast, is that forecast implies a level of certainty that, even in principle, simply isn’t achievable. I used the simile the other day that the Fed’s job is like trying to repair a Seiko watch based on a Timex manual, using a sledgehammer operated by a robot controlled from the next room, in the dark, and I stand by it.

The value, therefore, has to be in the thought process rather than the conclusions, and in a range of possible outcomes ranked by probability rather than a point estimate. This fits poorly with questions such as “What will the S&P 500 close at year-end?”

My recent post on the stock market in 2014 is a good example of how I think about things. I tried to lay out the variables in an organized way, explain the most important factors affecting them and the reasoning behind my points, and suggest ranges for a solution under different scenarios, before finally concluding that the S&P 500 would close 2014 at around 1,800.

The market then proceeded to take off and run up to almost 1,850 at year-end 2013.

Was I wrong? Well, we don’t know yet, which is kind of the point. My central probability range was between 1,750 and 1,880, or about a −3-percent to +4-percent range. A lot has to happen between now and the end of the year.

More to the point, I outlined my reasoning and my chain of logic and laid out my evidence. Anyone reading the piece could identify where they thought I was wrong and use their own data to support their conclusions. I also outlined what would have to happen for me to be wrong, and anyone watching will be able to tell when things start to differ from what I thought.

I write this today because I heard a very detailed and reasonably compelling presentation this morning on why, in fact, multiple expansion—and thus the stock market rise—will continue. Although I think I substantially disagree with many of the conclusions, the value of the presentation was in the data provided and the clearly outlined reasoning. I believe they may have omitted some key causal relationships, but I really need to go back and think the argument through in more detail. Either way, I will benefit, and my analysis will be better.

If I end up agreeing with part or all of that argument, or others, I will also change my mind—and my analysis and conclusions. This gets back to why I dislike forward forecasts: as facts come out, any reasonable person will modify his thinking. To publish something as a forecast is to presume that current conditions won’t change, and potentially lock yourself into a position.

The book The Signal and the Noise, which I reviewed last May, includes a good discussion of what makes a forecaster successful, and in which domains. A useful distinction is between hedgehogs, who have one trick (just as the real hedgehog does), and foxes, who have many tricks.

In the media domain, the successful forecasters tend to be hedgehogs; they have one consistent forecast, which they make regularly and in detail, and they benefit when they are right. Right or wrong, however, they make great TV, because TV is not nuance’s friend. Foxes, on the other hand, do less well in the media, because they hedge and change their minds—but they usually turn out to be more accurate overall.

In this sense, I am very much, by nature and decision, a fox. The basic context of my thinking should be clear from other posts on this blog. But for the 2014 outlook, I want to be sure I’m giving you, the reader, something that will be useful to inform your own thinking, not just a set of predictions.

I’m working on it. :)

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