Wall Street Deals With Lousy Economic Forecast: Caroline Baum
By Caroline Baum
New York, March 12 (Bloomberg) -- Wall Street is a strange place. Sometimes the firms that give the worst advice have the best reputations.
Company analysts have garnered most of the attention in the past year for various conflicts of interest between the stocks they recommend and the investment banking business they attract.
Wall Street economists may lack a conflict of interest, but the recommendations implied in their weak-economy forecasts were no more reliable than the ``buy'' on Enron stock as the company was imploding.
At the start of the year, Wall Street was uniformly glum about the economic outlook. The average forecast for first-quarter real gross domestic product growth of the 55 economists who participate in the Wall Street Journal's semi-annual forecasting survey was 0.9 percent. The survey ran in the Jan. 4 edition of the paper.
Practically every new piece of economic information engendered upward revisions to growth forecasts. Jim Glassman, senior U.S. economist at J.P. Morgan Chase, readily admits he's revised his GDP forecast up four times since the start of the year.
Clearly the strength of the U.S. economy caught Wall Street economists with their collective pants down. A few got it right. Ram Bhagavatula, chief economist at Royal Bank of Scotland Financial Markets, had the second-highest first-quarter GDP forecast in the Wall Street Journal survey of 4 percent. The consensus has been moving in the direction of what two months ago was Bhagavatula's outlier.
Simple Simon
Another economist who got it right was Paul Kasriel, director of economic research at Northern Trust Corp. Kasriel attributes his success at picking a turning point to his ``proprietary'' model, which includes real M2.
``I don't understand why economists don't use it,'' Kasriel says. ``I can understand why they would say they don't use M2. It's so simple that people who pay them the big bucks would wonder why they pay them. Why don't they use it and just not tell everyone they use it?''
Kasriel has a point. How can economic research departments justify their existence, not to mention their salaries, if they were revealed to be using such a simple model?
``It's in the public domain,'' Kasriel says. ``It's in the Index of Leading Economic Indicators. They've already done the work for you. They've invented the wheel even if (Paul) Krugman still doesn't understand it.''
Approach/Avoidance
Henry Willmore, chief U.S. economist at Barclays Capital Group, was right up there with the bulls in the WSJ survey with his forecast for 3.5 percent first-quarter growth. Like Kasriel, Willmore describes his forecasting model as ``simple.''
``Extremely low interest rates and aggressive easing by the Fed do work,'' Willmore says. ``The inventory cycle, which was large last year and enormous in the fourth quarter, had to turn.''
Only 15 of the 55 economists surveyed thought growth would exceed 2 percent in the first quarter. What does that say about the science or art of forecasting?
Not to worry. The Federal Reserve didn't see growth coming either. Those who missed the turn in economic activity are in good company.
`As We Told You'
Wall Street has various ways of dealing with a lousy forecast. One is to disown it, pretend it never existed. This is the most frustrating method for the reader. One day, the economy is mired in recession with no chance of any return to growth and not even the remotest possibility that the Fed would raise interest rates. The next day, it's 3.5 percent growth and rate increases starting by the middle of the year. We never get to see the thought process involved in the transition.
This group doesn't tell you if the model was wrong, the modeler's assumptions were wrong or if they don't know the difference. I suspect that on some level the changeroos hope we will think it's our fault, that we missed the day's installment where the forecast revision was unveiled.
At the opposite end of the spectrum are those who announce a forecast change with the banner-like headline, ``We have changed our forecast.'' These folks are so late that they have no choice but to call attention to their tardiness. In owning up to the bad call, economists generally provide a roadmap as to where they went wrong. We learn that what went wrong was that the numbers came in stronger than expected.
Self-Help
Another tried-and-true formula is self-flagellation, with the self-flagellator pretending he's involved in some kind of group therapeutic self-exploration seminar. Morgan Stanley chief global economist Stephen Roach used this tactic yesterday in his daily economic comment. After delineating the five areas where he went wrong, Roach basically concluded that he was still convinced his no-recovery/double-dip forecast was correct.
We, the reader, are supposed to be charmed by the economist's frankness and ability to confront in a public forum the error of his ways. The effect, however, is usually just the opposite.
``I still like the same old story I've been telling for sometime,'' Roach wrote at the end of his piece, exposing for those who didn't get it the self-indulgent exercise. |
