The Perils of Forecasting Craig Bodenstab 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. Page 1
Some fields of study are cumulative, but economics is largely cyclical H He Li Be B C N O F Ne Na Mg Al Si P S Cl Ar K Ca Sc Ti V Cr Mn Fe Co Ni Cu Zn Ga Ge As Se Br Kr Rb Sr Y Zr Nb Mo Tc Ru Rh Pd Ag Cd In Sn Sb Te I Xe Cs Ba La Hf Ta W Re Os Ir Pt Au Hg Tl Pb Bi Po At Rn Fr Ra Ac Rf Db Sg Bh Hs Mt Ds Rg Cn Uut Fl Uup Lv Uus Uuo Ce Pr Nd Pm Sm Eu Gd Tb Dy Ho Er Er Tm Yb Lu Th Pa U Np Pu Am Cm Bk Cf Es Fm Md No Lr Page 2
“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.” – Lao Tzu Page 3
Forecasting has long been a profitable endeavour…for the forecasters 1500s Five hundred years later Page 4
Forecasting record of economists Forecasted and actual US inflation, 1984 through June 2015 6% R 2 (unlagged) 87% 5% R 2 (lagged) 71% 4% 3% 2% 1% 0% 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 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 Actual Federal Reserve Bank of Philadelphia survey of professional forecasters (lagged) Source: Bloomberg. Page 5
Forecasting record of bond analysts Forecasted and actual US 10-year Treasury yields, 1992 through June 2015 9% R 2 (unlagged) 90% 8% 7% R 2 (lagged) 65% 6% 5% 4% 3% 2% 1% 0% 91 92 92 93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13 13 14 14 15 15 16 Actual Federal Reserve Bank of Philadelphia survey of professional forecasters (lagged) Source: Bloomberg. Page 6
Forecasting record of equity analysts Forecasted and actual earnings per share of the S&P 500 Index, 1985 through August 2015 140 R 2 (actual vs lagged actual) R 2 (actual vs unlagged forecast) 93.6% 99.4% 120 R 2 (actual vs lagged forecast) 94.2% 100 80 60 40 20 0 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 Actual I/B/E/S consensus forecast (lagged) Source: Datastream. Page 7
Forecasting record of equity analysts Forecasted and actual earnings per share of the S&P 500 Index, 1985 through August 2015 160 160 R 2 (unlagged) 98% 140 140 R 2 (lagged) 82% 120 120 100 100 80 80 60 60 40 40 20 20 0 0 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 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 Actual I/B/E/S three-year consensus forecast (lagged) Source: Datastream. Page 8
Forecasting record of equity analysts Forecasted and actual price of the Shangai Shenzhen CSI 300 stock index, 2006 through August 2015 7000 7000 6000 6000 R 2 (unlagged) 81% R 2 (lagged) 13% 5000 5000 4000 4000 3000 3000 2000 2000 1000 1000 0 0 05 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13 13 14 14 15 15 16 Actual Bloomberg consensus estimate (lagged) Source: Bloomberg. Page 9
Forecasting record of oil analysts Forecasted and actual West Texas Intermediate crude oil price, 2005 through August 2015 160 160 140 140 120 120 100 100 80 80 60 60 R 2 (unlagged) 77% 40 40 R 2 (lagged) 5% 20 20 0 0 04 05 05 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13 13 14 14 15 15 16 Actual One-year oil price forecast (lagged) Source: Bloomberg. Page 10
Forecasting record of Canadian money managers Forecasts compiled by Mercer for their 2014 Fearless Forecasting survey Median forecast (%) Actual results (%) Difference (pp) 8.0 10.6 2.6 S&P / TSX Composite 8.0 23.9 15.9 S&P 500 (C$) 9.1 4.1 (5.0) MSCI EAFE (C$) 9.0 14.1 5.1 MSCI ACWI (C$) FTSE TMX Canada 1.5 8.8 7.3 Universe Bond FTSE TMX Canada Long 0.5 17.5 17.0 Bond FTSE TMX Canada Real 0.5 13.2 12.7 Return Bond Page 11
Forecasting record of the US government US Congressional Budget Office 2001 forecast for 2011 fiscal balance and actual 2011 balance, US$ billions 7,000 7,000 5,600 6,000 6,000 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 (3,500) 1,000 1,000 0 0 (1,600) (1,000) (1,000) (1,500) (2,000) (2,000) (3,000) (3,000) (1,400) (4,000) (4,000) (1,400) (5,000) (5,000) (1,300) (6,000) (6,000) (1,000) (6,100) (7,000) (7,000) Forecast Forecast Economic Economic Bush Tax Cuts Discretionary War Spending Bush Tax Cuts Discretionary War Spending Interest Interest Other Revenue Other Spend Other Revenue Other Spend Actual Actual Source: Congressional Budget Office. Page 12
Do GDP growth forecasts help predict equity returns? Real equity returns vs real gross domestic product (GDP) growth, 1970-2009 30% 25% 20% Annualised real equity returns 15% 10% 5% 0% (5%) (10%) (15%) (20%) (6%) (4%) (2%) 0% 2% 4% 6% 8% 10% Annualised real GDP per capita growth 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. Page 13
Do GDP growth forecasts at least help us avoid the worst markets? Annualised real equity return and annualised growth in real GDP per capita, 1900 to 2009 8% Annualised real GDP per capita growth Annualised real equity return 6% 4% 2% 0% SAf Ger Swi Bel UK Aus US Net Can Den NZ Fra Ire Spa Swe Ita Nor Fin Jap Source: Dimson, Marsh, Staunton, Triumph of the Optimists; authors' updates. Page 14
Does forecasting major changes in an industry help in stock selection? Technology vs tobacco 1,000,000 IBM Altria (Philip Morris) 4,625x Digital Equipment British American Tobacco Total return (rebased to 100 at 1 Jan 1975) 1,444x 100,000 10,000 43x 1,000 7x 100 10 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: DataStream. Page 15
You can control the price you pay for assets TOPIX average starting P/E, by quintile, and average subsequent annualised 10-year return, 1973 to 2014 47.6 50 Starting P/E ratio Annualised 10-year subsequent returns (%) 40 32.8 30 24.4 20.4 20 16.4 8.0 10 7.4 7.0 0 (0.6) (3.9) (10) 1st 2nd 3rd 4th 5th Source: Orbis. Page 16
Valuation is what matters Africa All Share Index starting P/E ratio and subsequent annualised 4-year return, 1960 through June 2014 50% Starting P/E based on actual earnings 40% Annualised 4-year subsequent return Starting P/E based on trendline earnings 30% 20% 10% 0% (10%) (20%) 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Starting P/E ratio Source: Allan Gray (Pty) Ltd. Page 17
The bad news and the good news The bad news The good news Macroeconomic forecasting is incredibly difficult The most important thing is the price you pay Even accurate economic forecasts won’t necessarily The price you pay is entirely within your control The price you pay help you make better investment decisions Focus on what you can control Page 18
“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 Page 19
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