How Much Value Do Economic Forecasts Hold?

Last Updated Apr 29, 2009 5:42 PM EDT

If you're a typical investor, you probably find it easy to stick to your asset-allocation plan when things are going well. Bear markets, however, frequently lead to investor panic and a frenzied search for new information, including economic forecasts -- themselves the underlying basis for most stock market forecasts. But do these predictions really tell us anything useful?

A new study, "How Accurate Are Forecasts in a Recession?," by Federal Reserve Bank of St. Louis economist Michael W. McCracken, found that economic forecasters do even worse during recessions.Using the Survey of Professional Forecasters as his database, McCracken reviewed quarterly forecasts from the third quarter of 1981 through the third quarter of 2007. He found that forecaster errors were four times larger when the economy was in recession than when it was growing.

So you should be pretty leery about putting too much stock in forecasts, as many of the best known names in investing have noted. Benjamin Graham, legendary investor and author of Security Analysis, offered this observation:
If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market.
William Sherden came to a similar conclusion in his excellent book, The Fortune Sellers. He noted:
Despite recent innovations in information technology and decades of academic research, successful stock market prediction has remained an elusive goal. In fact, the market is getting more complex and unpredictable as global trading brings in many new investors from numerous countries, computerized exchanges speed up transactions, and investors think up clever schemes to try to beat the market. Overall, we have not made progress in predicting the stock market, but this has not stopped the investment business from continuing the quest, and making $100 billion annually doing so.
Even Steve Forbes likes to quote his grandfather, who founded the magazine that bears the family name, thusly: "You make more money selling the advice than following it."
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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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