The Perils of Forecasting Craig Bodenstab Orbis Investment Advisory - - PowerPoint PPT Presentation

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Orbis Investment Advisory (Canada) Limited is an exempt market dealer. This communication is not intended to be and should not be regarded as soliciting an investment in any investment products offered by Orbis.

The Perils of Forecasting

Craig Bodenstab

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Some fields of study are cumulative, but economics is largely cyclical

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“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.”

– Lao Tzu

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Forecasting has long been a profitable endeavour…for the forecasters 1500s Five hundred years later

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Source: Bloomberg.

Actual Federal Reserve Bank of Philadelphia survey of professional forecasters (lagged) 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 0% 1% 2% 3% 4% 5% 6% 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 R2 (unlagged) 87% R2 (lagged) 71%

Forecasted and actual US inflation, 1984 through June 2015

Forecasting record of economists

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Source: Bloomberg.

Actual Federal Reserve Bank of Philadelphia survey of professional forecasters (lagged) 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 R2 (unlagged) 90% R2 (lagged) 65%

Forecasted and actual US 10-year Treasury yields, 1992 through June 2015

Forecasting record of bond analysts

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Source: Datastream.

Actual I/B/E/S consensus forecast (lagged) 20 40 60 80 100 120 140 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 R2 (actual vs unlagged forecast) 99.4% R2 (actual vs lagged forecast) 94.2% R2 (actual vs lagged actual) 93.6%

Forecasted and actual earnings per share of the S&P 500 Index, 1985 through August 2015

Forecasting record of equity analysts

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Source: Datastream.

Actual I/B/E/S three-year consensus forecast (lagged) 20 40 60 80 100 120 140 160 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 20 40 60 80 100 120 140 160 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 R2 (unlagged) 98% R2 (lagged) 82%

Forecasted and actual earnings per share of the S&P 500 Index, 1985 through August 2015

Forecasting record of equity analysts

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Source: Bloomberg.

Actual Bloomberg consensus estimate (lagged) 1000 2000 3000 4000 5000 6000 7000 05 06 07 08 09 10 11 12 13 14 15 1000 2000 3000 4000 5000 6000 7000 06 07 08 09 10 11 12 13 14 15 16 R2 (unlagged) 81% R2 (lagged) 13%

Forecasted and actual price of the Shangai Shenzhen CSI 300 stock index, 2006 through August 2015

Forecasting record of equity analysts

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Source: Bloomberg.

Actual One-year oil price forecast (lagged) 20 40 60 80 100 120 140 160 04 05 06 07 08 09 10 11 12 13 14 15 20 40 60 80 100 120 140 160 05 06 07 08 09 10 11 12 13 14 15 16 R2 (unlagged) 77% R2 (lagged) 5%

Forecasted and actual West Texas Intermediate crude oil price, 2005 through August 2015

Forecasting record of oil analysts

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Forecasting record of Canadian money managers

Forecasts compiled by Mercer for their 2014 Fearless Forecasting survey

Median forecast (%) S&P / TSX Composite

8.0

S&P 500 (C$)

8.0

MSCI EAFE (C$)

9.1

MSCI ACWI (C$)

9.0

FTSE TMX Canada Universe Bond

1.5

FTSE TMX Canada Long Bond

0.5

FTSE TMX Canada Real Return Bond

0.5

Difference (pp)

2.6 15.9 (5.0) 5.1 7.3 17.0 12.7

Actual results (%)

10.6 23.9 4.1 14.1 8.8 17.5 13.2

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(7,000) (6,000) (5,000) (4,000) (3,000) (2,000) (1,000) 1,000 2,000 3,000 4,000 5,000 6,000 7,000

Forecast Economic Bush Tax Cuts Discretionary War Spending Interest Other Revenue Other Spend Actual

Forecasting record of the US government

US Congressional Budget Office 2001 forecast for 2011 fiscal balance and actual 2011 balance, US$ billions

5,600 (6,100) (3,500) (1,600) (1,500) (1,400) (1,400) (1,300) (1,000) (7,000) (6,000) (5,000) (4,000) (3,000) (2,000) (1,000) 1,000 2,000 3,000 4,000 5,000 6,000 7,000

Forecast Economic Bush Tax Cuts Discretionary War Spending Interest Other Revenue Other Spend Actual

Source: Congressional Budget Office.

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Source: Elroy Dimson, Paul Marsh, and Mike Staunton, Global Investment Returns Yearbook 2010, Credit Suisse Research Institute, 2010. Elroy Dimson, Paul Marsh, and Mike Staunton, Triumph of the Optimists, Princeton University Press, 2002.

Real equity returns vs real gross domestic product (GDP) growth, 1970-2009

Do GDP growth forecasts help predict equity returns?

(20%) (15%) (10%) (5%) 0% 5% 10% 15% 20% 25% 30% (6%) (4%) (2%) 0% 2% 4% 6% 8% 10% Annualised real equity returns Annualised real GDP per capita growth

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Do GDP growth forecasts at least help us avoid the worst markets?

Source: Dimson, Marsh, Staunton, Triumph of the Optimists; authors' updates.

Annualised real equity return and annualised growth in real GDP per capita, 1900 to 2009

0% 2% 4% 6% 8% SAf Ger Swi Bel UK Aus US Net Can Den NZ Fra Ire Spa Swe Ita Nor Fin Jap Annualised real GDP per capita growth Annualised real equity return

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Does forecasting major changes in an industry help in stock selection?

Technology vs tobacco

Source: DataStream.

10 100 1,000 10,000 100,000 1,000,000 1975 1980 1985 1990 1995 2000 2005 2010 2015 Total return (rebased to 100 at 1 Jan 1975) IBM Altria (Philip Morris) Digital Equipment British American Tobacco 4,625x 1,444x 43x 7x

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You can control the price you pay for assets

Source: Orbis.

TOPIX average starting P/E, by quintile, and average subsequent annualised 10-year return, 1973 to 2014 16.4 20.4 24.4 32.8 47.6 7.0 7.4 8.0 (0.6) (3.9) (10) 10 20 30 40 50 1st 2nd 3rd 4th 5th Starting P/E ratio Annualised 10-year subsequent returns (%)

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Valuation is what matters

Source: Allan Gray (Pty) Ltd.

Africa All Share Index starting P/E ratio and subsequent annualised 4-year return, 1960 through June 2014

(20%) (10%) 0% 10% 20% 30% 40% 50% 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Annualised 4-year subsequent return Starting P/E ratio Starting P/E based on actual earnings Starting P/E based on trendline earnings

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The bad news and the good news

The bad news

Macroeconomic forecasting is incredibly difficult Even accurate economic forecasts won’t necessarily help you make better investment decisions

The good news

The most important thing is the price you pay The price you pay is entirely within your control

Focus on what you can control

The price you pay

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“It ain't what you don’t know that gets you into trouble. It’s what you know for sure that just ain't so.”

– Mark Twain