Why Economists Are Always Wrong

"It’s tough to make predictions, especially about the future." … Yogi Berra

My firm, LCM Capital Management, has always despised the New Year since our firm's inception more than 25 years ago.  The reason: it's when our financial industry parades out their analysts, strategists, and economists, aka "experts", and tell the investing population what they believe is going to happen in the coming year.  Which stocks or sectors to own or not to own, what will happen with the economy and interest rates?  The problem is, they are almost always wrong and yet investors seem to take their guesses, and that's all they are, as Gospel.  Do your portfolio a favor, as our clients tend to do, and turn-off CNBC and all the talking heads on TV this time of year.  

These "experts," armed with complex models, historical data, and sophisticated analytics can play a role in shaping public policy and guiding business strategies and forming investment decisions.  They project confidence in their ability to predict the future and yet, year after year, economic forecasts fall wide of the mark.

So why are economists, analysts and market strategists so often wrong, and what does this mean for those who invest based on their predictions, particularly investors nearing retirement?

Economic forecasting is inherently complex because economies are not closed systems.  Think about our world today and how inter-connected it all is.  The world economies are influenced by countless interdependent factors, many of which are unpredictable.  Natural disasters, geopolitical tensions, technological disruptions, and consumer behavior, for example, all can upend even the most carefully constructed economic models.

These "experts" typically rely on historical data to project future trends.  While history does provide valuable context, it can also be very misleading.  As Nobel laureate Daniel Kahneman once said, “The idea that the future is unpredictable is undermined every day by the ease with which the past is explained.”

I am sure at some point you have either been told or read the following, "past performance is no guarantee of future results" and yet we often forget this.

Recent history offers several glaring examples of economists getting it wrong.  These missteps underscore the inherent challenges of economic forecasting and the potential pitfalls of relying on predictions.

The Federal Reserve and Inflation (2021–2022) – In 2021, Federal Reserve Chair Jerome Powell famously described rising inflation as “transitory.”  The Fed anticipated that inflationary pressures, driven by supply chain disruptions and pandemic-related stimulus, would subside quickly.  Instead, inflation surged to multi-decade highs, forcing the Fed into its most aggressive interest rate hiking cycle in 40 years.  At the end, when the Fed was finally done raising rates, Fed Chairman Powell said, "We now understand better how little we understand about inflation." 

This miscalculation wasn't just a simple slip-up—it had real, lasting consequences.  Businesses, consumers, and investors made decisions based on the Fed's assurances, only to face unexpected economic challenges as inflation persisted.  And think about this: there are more than 400 PhD economists employed by the Federal Reserve Board and they were dead wrong as to how high, how long, and how severe inflation would be and how deep the subsequent recession would last. I am sure these are some of the brightest minds in our country and yet, even with all of the data and information at their fingertips, they were wrong. However, common sense and the lessons of the past led many "experts" to believe that the inverted yield curve caused by the Fed's unprecedented monetary tightening signaled a recession ahead.  They were incorrect as well.  So how possibly can someone, for example say Jim Cramer, predict what will happen this year or the next?  He can't, and while I find Mr. Cramer sometimes entertaining, he is a journalist first and foremost.

Another recent example, as the world emerged from the COVID-19 pandemic, many economists predicted a sluggish, protracted recovery.  Instead, global economies bounced back faster than anyone expected, thanks to an unprecedented wave of fiscal and monetary stimulus.  Consumer spending surged, and labor markets tightened, defying predictions of a drawn-out downturn.  During the pandemic, as tech stocks soared, many economists and analysts warned of an impending collapse akin to the dot-com bubble of the early 2000s.  Sure, some overvalued companies took a hit, but the sector turned out to be much more resilient than expected and the S&P 500 rose by over 18% that year, way above the historical average rate of return of 7.71% when adjusted for inflation and including dividends.

But let's cut these "experts" some slack, after all they are all human beings and as a result, are just as prone to mental shortcuts and biases as the rest of us.  Confirmation bias, which is the tendency of people to favor information that confirms or strengthens their beliefs or values, is difficult to dislodge once affirmed and can lead them to favor data that supports their existing theories.  Overconfidence bias can result in undue certainty about uncertain outcomes.  Just to be clear, we are not believers that AI or computers etc. can do any better predicting the future.  They can't.  They all use historical data to help them formulate their best guesses and always remember, in the end, it is still just a guess.

So what should investors do?  First, your New Years resolution should be to turn off CBNC or whatever your favored business channel is, or at the very least, mute it!  By spreading your investments across asset classes, sectors, and geographies, you can help reduce your exposure to any single economic or financial outcome.  A well-diversified portfolio can help mitigate the risks associated with inaccurate forecasts. Maintaining a long-term outlook can help you weather periods of volatility and uncertainty.  Lastly, control what you can control.  While you can't control inflation rates or GDP growth, you can control your TV's volume, and the fees you pay, as well as your savings rate, spending habits, and investment discipline.  Prioritizing these factors can have a more significant impact on your financial future than any forecast.  By realizing that the future is uncertain and focusing on what you can control, you'll be better equipped to navigate the ever-changing economic landscape as well as become a happier person.

In the end, realize that these "experts" are likely bright people with plenty of information and research available to them.  However, they are only making an educated guess at best because if they actually knew what was going to happen, they would already be retired.  The late founder of Vanguard, Jack Bogle, once said, "Research has no net value…no one has been able to validate that stock research has any value. If research had value, it would be called proprietary and therefore would be extremely expensive and unavailable for public viewing"

Therefore, stay informed about economic trends, but approach all predictions with a healthy dose of cynicism.  Too often, well-informed economists' predictions are far from accurate or reliable.  The complexity of global economies, combined with the unpredictability of human behavior and external shocks, makes accurate forecasting a near-impossible task.

Remember what the famed economist John Kenneth Galbraith once said, "There are two kinds of forecasters: those who don't know, and those who don't know they don't know."

There is a better way.

LCM Capital Management