Forecasting Consumer Guide Part III: Historical Comparisons

There is a forecasting feast in USA Today, offering us a nice summary of the most important viewpoints.

Several of the comments deserve review, but let’s start with that of Tom Au.  Tom is obviously a really smart guy, well-educated, and with great experience at Value Line in identifying value investments.  He is the author of a highly regarded book on value investing.

Tom’s view is that this decade is like the 70’s:

The economy is very much like it was in the ’70s.  The stock market was also in a funk in the 70’s gaining a meager 17.2% in the decade.

He cites the Iraq war, the spike in energy prices, and the fall in President Bush’s approval ratings as similarities to Vietnam, the Arab oil Boycott, and the Nixon impeachment and resignation.  Sometimes his comments also thrown in corporate malfeasance and trials as akin to the Nixon situation.

Tom Au is not alone in invoking the "stagflation term" to describe what they think might happen in this decade.

Since Tom is an honors graduate of Yale, I am amazed at the cavalier and superficial nature of this comparison.  In particular, consder his points:

  1. Iraq is not Vietnam — and we all hope it never will be.  Let me be clear that I do not disparage the commitment of those who served and sacrificed in Iraq, including the children of good friends and neighbors and my nephew.  Having said this, the losses are different by the order of 50-1; there was a draft; there was a widespread protest movement that disrupted much activity and which led to armed conflict and death; and I am just getting started.  Vietnam split the country in a way different from any war before or since.
  2. The energy spike is totally different.  It was much higher in real terms in the 70’s and it was sparked by OPEC’s intention to punish countries supporting Israel.  Energy was also a larger component in overall spending.  The current situation is different on all counts.
  3. Anyone comparing the current administration’s dip in the polls, even with the recent use of the "Impeachment" word, needs to do a real study of the effect of the Watergate hearings and Nixon’s resignation.  Maybe young people just do not realize how vulnerable everyone felt when the Commander-in-Chief was virtually powerless in the middle of the Cold War.  For a time, there was no Vice-President, since Agnew had also resigned.  We were paralyzed for months during the Watergate hearings and the activities of the special prosecutor.  It took a couple of healing years with Gerald Ford filling in for political stability to be regained.  This is nothing like Bush’s poll ratings, or Ken Lay, or anything like what we are seeing now.  It is not close.

Moving beyond the very superficial comparisons Tom makes, he should take a look at econonic growth, inflation, and interest rates during that era.  He is speculating (against the prevailing economic consensus) that these factors will destroy a currently strong economy.  That was not the case in the 70’s.

It is a very big prediction.  I would be much more interested in Tom’s viewpoint if he were to write a "compare and contrast" piece on the two eras.  It should be something significant and reflective, displaying the same level of scholarship that he shows in his book.

Conclusion:  Consumers of forecasts should be wary of facile historical comparisons.  Look for some depth of analysis and intellectual rigor.

Forecasting Consumer Guide Part III: Historical Comparisons

There is a forecasting feast in USA Today, offering us a nice summary of the most important viewpoints.

Several of the comments deserve review, but let’s start with that of Tom Au.  Tom is obviously a really smart guy, well-educated, and with great experience at Value Line in identifying value investments.  He is the author of a highly regarded book on value investing.

Tom’s view is that this decade is like the 70’s:

The economy is very much like it was in the ’70s.  The stock market was also in a funk in the 70’s gaining a meager 17.2% in the decade.

He cites the Iraq war, the spike in energy prices, and the fall in President Bush’s approval ratings as similarities to Vietnam, the Arab oil Boycott, and the Nixon impeachment and resignation.  Sometimes his comments also thrown in corporate malfeasance and trials as akin to the Nixon situation.

Tom Au is not alone in invoking the "stagflation term" to describe what they think might happen in this decade.

Since Tom is an honors graduate of Yale, I am amazed at the cavalier and superficial nature of this comparison.  In particular, consder his points:

  1. Iraq is not Vietnam — and we all hope it never will be.  Let me be clear that I do not disparage the commitment of those who served and sacrificed in Iraq, including the children of good friends and neighbors and my nephew.  Having said this, the losses are different by the order of 50-1; there was a draft; there was a widespread protest movement that disrupted much activity and which led to armed conflict and death; and I am just getting started.  Vietnam split the country in a way different from any war before or since.
  2. The energy spike is totally different.  It was much higher in real terms in the 70’s and it was sparked by OPEC’s intention to punish countries supporting Israel.  Energy was also a larger component in overall spending.  The current situation is different on all counts.
  3. Anyone comparing the current administration’s dip in the polls, even with the recent use of the "Impeachment" word, needs to do a real study of the effect of the Watergate hearings and Nixon’s resignation.  Maybe young people just do not realize how vulnerable everyone felt when the Commander-in-Chief was virtually powerless in the middle of the Cold War.  For a time, there was no Vice-President, since Agnew had also resigned.  We were paralyzed for months during the Watergate hearings and the activities of the special prosecutor.  It took a couple of healing years with Gerald Ford filling in for political stability to be regained.  This is nothing like Bush’s poll ratings, or Ken Lay, or anything like what we are seeing now.  It is not close.

Moving beyond the very superficial comparisons Tom makes, he should take a look at econonic growth, inflation, and interest rates during that era.  He is speculating (against the prevailing economic consensus) that these factors will destroy a currently strong economy.  That was not the case in the 70’s.

It is a very big prediction.  I would be much more interested in Tom’s viewpoint if he were to write a "compare and contrast" piece on the two eras.  It should be something significant and reflective, displaying the same level of scholarship that he shows in his book.

Conclusion:  Consumers of forecasts should be wary of facile historical comparisons.  Look for some depth of analysis and intellectual rigor.

Forecasting Consumer Guide — Part II: Level versus Direction

About this time a year there was a CNBC program involving three excellent and savvy market observers.  Ron Insana was the host and his guests were Art Hogan and Louis Navellier.  They had a general discussion about the market and valuation.  The guests agreed that values were attractive given earnings forecasts, the state of the economy, and interest rates.  They both seemed to feel that the market was undervalued on these criteria.

But when Ron asked for forecasts, Art Hogan predicted up 8% and Louis Navellier called for up 35% or so, consistent with his assessment of the undervaluation.  Insana seemed a bit puzzled by Hogan’s forecast, given his apparent attitude about valuation.  He asked "Why 8%" and Hogan answered that he expected earnings growth to be about 8%.

This is typical of the difference in approaches between strategists for a firm and fund managers.  The strategists, even if they believe that the current market multiple does not reflect forward earnings and interest rates, do not predict a multiple expansion.  They accept the current market verdict on valuation as "given" and look only for factors that can change direction.  These pundits speak in terms of "headwinds" or "tailwinds" or other new developments.  They are implicitly accepting the Efficient Market Hypothesis, that the underlying valuation verdict will not change.  Even if a strategist is a bit more bullish or bearish than his colleagues, there is little reason to take an extreme view.  Being a little more bullish is enough to claim a superior record without looking foolish.

It is different for a fund manager like Navellier.  He can do his bottoms-up analysis on earnings and expect that eventually multiples and interest rates will revert to their traditional relationship.  It does not really matter if the market is only up 10 or 15 percent, since he has his investors properly positioned.  Please note that this approach is an honest forecast of where the market should go to achieve the analyst’s fair value target.

A consumer of forecasts should listen carefully to whether the pundit talks about valuation.  If there is a discussion of valuation, there are crucial questons:  Does the pundit merely talk about average P/E ratios, or is there some acknowledgement of why interest rates are important?  Is P/E discussed as reported earnings or operating earnings?  Is it a backward-looking "forecast" or does it acknowledge expected or forward earnings?

You can tell a lot from what is left out, not just what is said.