The Independent Market Observer

Lessons in Preparing a Market and Economic Outlook

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on May 31, 2017 4:49:35 PM

and tagged Economics Lessons

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preparing an outlookSpring conference season is over. I’m back at the office and happy to be here. Rather than relaxing, however, I am now wrestling with my next big project: preparing an outlook for the second half of the year. What will happen? And why?

These are difficult questions to answer. I can generate a reasonable outline of where we are, make some good extrapolations as to what might happen, and throw in a pinch of outside-the-box thinking—but it’s possible I could still be substantially wrong in at least one of my theorems. 

How so? Well, unlike physics, which deals with (mostly) known variables and laws, markets and economics are all about people. And as the Harvard Law of Biology states, “Under the most rigorously controlled conditions of pressure, temperature, volume, humidity, and other variables, any experimental organism will do as it damn well pleases.” Truer words were never spoken.

So why prepare a market and economic outlook? 

The purpose of preparing an outlook

First, because it's expected. We seem to have a deep-seated need to see around the corner, and we all spend a great deal of time trying to do just that. It’s the same need that keeps fortunetellers in business.

More seriously, and more importantly, trying to project the future gives us a frame through which to view our current circumstances. In many respects, this process forces us to adopt an outside viewpoint, as I have discussed before. And that means looking at larger trends, rather than at individual data points. By trying to reconcile present views with a future reality, we often end up having to reconsider those views.  

Preparing an outlook also gives us a great chance to see where that outlook might differ from current consensus thinking—and why. Opportunities in investing come from gaps between market perception and what will actually happen, and it is these gaps that (hopefully) come to light in an outlook analysis.

In this context, even the necessary numeric projections—where will the stock market be?—provide a useful way to evaluate what we think, why we think it, and how we might want to invest in the near- to medium-term future.

Understanding how we could be wrong

For me, the final piece of the puzzle in preparing an outlook is trying to understand how it could be wrong—and even more important, how and when we would know. I refer to this kind of thought process as “tripwire analysis.” When drawing any important conclusion, we should think about what would make it wrong, what we should monitor to see if it is wrong, and when we would decide that we were mistaken.

In the real world, and as a simple example, this is how and why I use the 200-day moving average as a tripwire for the stock market. When markets drop below that threshold, I start to pay attention, as this has been a good indicator of potential trouble ahead. For a less simple real-world example, this is why I track job growth, consumer and business confidence, and the yield curve every month, as they are (in ensemble) a great indicator of pending economic trouble. With both of these cases, you need to dig into the details, but having a couple of indicators that act as canaries makes life much easier.

The outlook, then, is not really about the projections but about how we get there and what the projections tell us about where we are right now. When it finally comes out, I suggest you read it in that light.

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