It’s in times like these that the hyperbolic media is at its shrillest. Why? Because it sells advertising. To appear as a legitimate source of financial punditry, the cable channels parade talking head economists across the screen to pontificate on urgent matters of the economy and the stock market. The only problem is they are wrong most of the time.
This is not to disparage economists. I have a degree in economics to go with my degree in finance so, I have a lot of respect for the study of economics and professional economists. But I am a professional investor who must view the world through a clear lens, which means having to acknowledge the limitations of the information I receive and especially the various points of view of that information. That’s why, whenever economists appear on TV, I see an imaginary warning label stamped on their foreheads.
Economists Don’t Add Value for Investors
With my educational background, I know that economists are very good at explaining what happened in the past, but they are not very good at predicting the future. There is absolutely nothing in their toolbox that would enable them to forecast the economy, let alone the stock market any better than the average investor. Yet, they continue to do just that, to the detriment of viewers enamored with their Ivy League pedigree.
Warren Buffet framed it best when in a 2016 video clip, he explained why economists don’t add much value for investors. “I don’t pay any attention to what economists say, frankly.” He went on, “Well, think about it. You have all these economists with 160 IQs that spend their life studying it, can you name me one super-wealthy economist that’s ever made money out of securities? No.”
“If you look at the whole history of [economists], they don’t make a lot of money buying and selling stocks, but people who buy and sell stocks listen to them. I have a little trouble with that,” he added.
What Economists Get Wrong
While there are a few commonly used economic models out there, most economists follow a similar methodology to break the economy down into various measurements to determine whether the economy is strong, average, or weak. Although they can indicate whether the economy is in a more expansionary or contractionary mode, they do little to provide any form of predictive, actionable intelligence for investors. The fact is, economic forecasting is not at all an exact science. While economists may be able to predict fiscal growth, they are as handicapped as the rest of us when it comes to predicting critical pivots in the economy, such as big upswings or major downturns.
One model, in particular, shared by many economists, suggested that on March 1, the economy had transitioned into a yellow phase – an early warning sign that a recession might be on the way. Then on April 30, about two months later, the model flashed a red light warning – that the economy was sliding into a recession with the implication that investors should consider getting out of the market.
The fact is that the stock market started turning south weeks before economists’ early warning on March 1, and it bottomed on March 23, five weeks before the red light warning on April 30. The rally between March 23 and April 30 was one of the strongest on record. The actions of the stock market were wholly divorced from economic activities, just as it is today.
In the wake of the coronavirus shutdown, it didn’t take an economist to know that the U.S. employment rate in April and May would be absolutely dismal. But, while economists predicted upwards of more than 20%, the key economic measure came in at 14.7% in April and improved to 13.3% in May. It was, as some economists acknowledged, the biggest forecast miss of their lives. While they did do better with the second-quarter GDP, which declined 32% after forecasts of around 30%, it wasn’t much of a stretch. Still, the stock market continued to rally.
To Forecast the Economy, Watch the Stock Market
Using lagging indicators such as the GDP or employment numbers, economists are equipped only to look back and analyze what happened. However, the stock market has always been a window into the future of the economy. Investors aren’t investing for today. They’re investing for six months to a year or more in the future. Most economists thought the Great Recession would last much longer than June of 2009 when it ended. However, the stock market began the longest bull market in history three months before on March 9. In fact, stocks almost invariably start to rise before the end of a recession.
In that respect, as was the case during past recessions, the stock market is a leading indicator. Is it predicting a bottom to the current recession? I guess like economists, we won’t really know until after it happens. But, as investors, we can’t afford to sit on the fence. Economists use their research and expertise to tell us what happened, leaving us on the fence. Investors need to use their knowledge, research, and experience to form a point of view of the world to be able to get off the fence and invest through all of this.
