Economic forecasts are often wrong but that doesn’t make them futile
Happy New Year and all that jazz.
Today, Tuesday 2 January, is of course the first working day of 2024 and so this is when all the predictions for what might or might not befall us over the next 365 days – it’s a leap year but New Year’s Day has already gone, so 366 days less one – with all the P&L clocks reset to zero. But let us be clear, New Year is for all intents and purposes not much more than an accounting exercise. It doesn’t coincide with the winter solstice, or for that matter the summer one if you happen to live on the southern hemisphere. It is not linked to moon phases or any other particular cosmological event. And even as far as accounting is concerned, not all countries or businesses respect 31 December as the day on which books are closed. In Japan, for instance, it’s 31 March and before the GFC, and before they found themselves forced to take out banking licenses in order to gain access to the Fed’s emergency liquidity facilities, US investment banks generally closed their books on 30 November.
The snivel I went to bed with on New Year’s Eve was still with me on New Year’s Day. I have fond memories of an old chum from school, one of our gang by the name of Rolf, who one year decided the had enjoyed the passing one and didn’t want to acknowledge the new one and proceeded to date all his work through until December 62nd and, I cannot recall in detail, possibly even beyond. Not that 2023 was for many of us such a sterling year unless we had gone limit long tech stocks and long-dated bonds and had been duly positioned through the last two months of the year. I was not.
The war in Ukraine is rumbling towards its second anniversary and the beginning of its third year while in Gaza the end to the conflict looks today to be further away than it had been when the IDF first crossed the border. Yemeni Houthi extremists have carried the conflict beyond the environs of Israel, Gaza, the occupied West Bank, and the northern border to Lebanon which has ceased to be a functioning state and is now little more than a plaything of Syria and of Iran-backed militias. I was myself in Kiryat Shmona, just a few miles from the Lebanese border in 1971 when it came under rocket attack from over the hill.
So, what does lie ahead? Dominic Lawson, son of the late Baron Lawson of Blaby who as Nigel Lawson served as Chancellor of the Exchequer to Margaret Thatcher and who died last April, had a piece in the weekend’s Sunday Times under the title “Forecasts have on tiny flaw: they’re useless”. The title is a little more promising than the content although he does gather some valid observations.. Thus, he writes “Ancient Rome called them augurs: a sort of priesthood among the patrician class who were trained in interpreting the behaviour of birds. From this method of analysis, it was allegedly possible to foresee whether the gods would look favourably on proposed policies: the Senate would debate the augurs’ report very seriously before coming to a decision. Nowadays, in the United Kingdom, we have economic forecasters, notably at the Bank of England and the Office for Budget Responsibility (OBR). They too have the manifestations of a priestly caste, their prognostications generating an immediate effect on investment decisions and political debate. At the turn of the year, however, almost everyone seems to join in this business — and it is a big business — of forecasting what will happen in the economy, politics, wars, you name it, over the next 12 months”.
It seems like half a lifetime ago – it was, by Teutates, half a lifetime ago – that I was invited by the City of London Business School, now Cass Business School, to teach the course “Economics for Traders”, the principal gist of which was that it’s irrelevant what the headline number of an economic release shows up as and all that counts is what the market expects it to be and how it is positioned before it hits the screens.
Lawson goes on “The other problem is that forecasts are right only by coincidence”. He continues by looking at the way in which the world had known that sooner or later a pandemic would befall us but that, quoting Dominic Cummings quoting Leo Tolstoy “Nothing was ready for a war which everybody expected”. It was Nigel Lawson who had coined the phrase “teenage scribblers” when referring to City analysts and his son quotes him by way of the observation “There is an understandable illusion that because economic outcomes, unlike, say, foreign policy outcomes, can be quantified, mathematical equations can be applied to the former area, even though they are clearly inapplicable to the latter. But it remains an illusion, since the fact that economic outcomes can be quantified in no way mitigates the uncertainty that attaches to all areas of human behaviour.”
In other words, we haven’t got a clue what is going to happen next. Not that we ever do, though we are now at the outset of 2024 sitting waiting for both economic and monetary inflection points. Morris Sachs – please permit me to congratulate him and his foil Liam Allen on the third anniversary of their Inside Baseball with Old Chestnut podcast – quite appropriately observed that we’re not here to be right, we’re here to make money.
Markets closed out the year on a high. It didn’t matter how often and how fervently the monetary authorities banged on that inflation has not yet been wrestled to the ground and that tight monetary policy was not about to be reversed, the party was on. At 4769.83 pts, the S&P 500 closed 2023 within less than spitting distance of its all-time high and up 24.23% on the year. The Nasdaq clocked a gain of 43.42% and with the tailwind of the year-end rally even the Dow made 13.70%. Over in Europe, the Dax did 20.31%, the CaC40 did 16.52% and it was only the FTSE100 that seriously missed out by closing up by only 3.78%, two thirds of which were added in December alone. The rates picture is no less staggering where the yield on the US 10-year note had fallen between October 19th and year end from an intraday high of 5.02% to close out 2024 at 3.87%. Over the same period, the yield on the two-year note has retreated from 5.22% to 4.28%. UK gilts have had a slightly rockier time with the yield on the 10 year having peaked in mid-August at 4.75%, then dropping to 4.21% by mid-September, rising to 4.70% by October 19th and then joining in the fun to close out the year at 3.54%.
Early year forecasts for 2023 were by and large only good for lighting fires and my guess is that ere long whatever is written and published this week will be going the same way. Whether it was Helmuth von Moltke or Carl von Clausewitz who first wrote that no battle plan survives first contact with the enemy is less important than the fact itself. Of course, it also includes that a battle plan, even if it does go to hell in a handcart, is required. And so, we need to begin the New Year with an idea of what we, all things being equal, might happen even if we know that equal they shall not remain.
I noted above that investment banks used to close out their financial year in November and that the big guys no longer do. That has had a profound influence on how since 2008 markets behave in January. Prior to the GFC, the investment banks stood there in December gleefully absorbing all the assets which the commercial banks were unloading ahead of year end. Then, as the banks began to reload inventory at the beginning of the New Year, the investment banks had the stock and sat there ringing the till. Their accepting the call to become fully licensed banks also obliged them to adopt Dec 31 as year-end. Now they too have flat books on Jan 2nd and have to join the scramble to strap on inventory. That adds to the early January squeeze. Even if the December rally looked to be more than just a tad overdone – it happened in pretty thin December markets – it’d take a brave man to begin the new year by going short. Early-year technicals will drive price action through until early- to mid-February unless of course, as in 2021, we have a major geo-political or seismic event which could overnight change the dynamics. The Pax Americana which has shaped the world since the collapse of the Soviet Union in 1989 has all but evaporated, so we will have to live with the possibility that even the January and February bid fests are now subject to a plethora of potential geopolitical landmines and tripwires and, to use Donald Rumsfeld’s words, unknown unknowns, none of which a market can be reasonably expected to price in.
I used to say to my clients that if 4casts were accurate, they wouldn’t be 4casts but 1casts. Yet, we need to stick something into the model. I’d be loathed to make a longer-term prediction and on technicals alone and along with the assumption that even if rates are not about to fall, they are with near certainty not going to rise, I’d have to feel that long equities and a concentration in the belly of the curve must look to be the most obvious way to take on the first six week of 2024. If you are happy to buy into the markets’ contentment with a soft landing scenario in the USA and if you dig a little bit deeper into China and come out believing, as many now do, that it has hit the bottom and is ready for a gentle recovery, the underperforming resource heavy FTSE must look like a pretty secure bet. Firming commodity prices along with rising freight rates – the Houthis and the central American drought which has upset the Panama canal are doing their bit – could, however, lead to a slowing in the decline in both PPI and CPI. Trying to plot the future of the oil price remains to sophisticated quant analysts a game of 4D chess and to simpletons like yours truly a case of pinning the tail on the donkey.
This year we will also have elections in many more places than the USA and the UK, although it will be those two that will be exercising our minds most. Some 50 years of entering election battles by competitively promising ever more benefits under the pretext of “social reform” was of course not populism whereas leaning up against critical race theory and out-of-control immigration is. Recently, the Neue Zürcher Zeitung (NZZ), Switzerland’s otherwise boringly level-headed leading quality paper, carried a column which suggested that wokeism and Islamism had now aligned themselves in the systematic dismantlement of Western culture and values. I confess to not having read the article although I think I might have a pretty good idea of how the argument was formulated. The two big elections of a US President and to the House of Commons will be accompanied in the States by to both the House and the Senate – all of the former, a third of the latter – are widely expected to end up with Trump in the White House and Kier Starmer in Number 10. In 2016 nobody expected Trump to win the nomination and then the election and in 2024 nobody expects him to lose. Starmer’s case is surely a lot clearer, and the debate seems to only be about how large his parliamentary majority might be. Were Nigel Farage to step up with his Reform party, he might not only split the Conservative but also the Labour vote. Even here there is opaqueness in the clarity. Rumsfeld’s known unknowns?
In a letter I recently wrote to a friend, I quoted an old Swiss bon mot which roughly translates as “Firstly, things will turn out differently than, secondly, you might have expected”. Methinks that’s not a bad motto for 2024.
So, off we trot into a new, foreshortened week. A week today I depart the wet and miserable Cotswolds – the prevailing subject of discussion is for how long and how intensely it will rain today, tomorrow and the day after – for my little island in the sun. If I go brown, it will be a proper suntan as opposed to here where it is more likely to be rust. I shall then be off duty for a full month. I like to think of all the money I leave behind, other than the flight, as being akin to direct development aid without the frictional cost of government or charities. That works, doesn’t it? Other than that, please permit me to wish you and all your family the best for 2024, be that in terms of health, personal safety, and economic security. I sincerely believe that this will be the year when the UK turns the post-Brexit corner and on that I shall place my bets. If I’m wrong, may I next year please move into a tent in your garden?
Write to us with your comments to be considered for publication at letters@reaction.life