Professional Double-Dip Guesses are “Probably” Wrong

August 17, 2010 at 11:42 pm 15 comments

As you may have noticed from previous articles, I take a significant grain (or pound) of salt when listening to economists and strategists like Peter Schiff, Nouriel Roubini, Meredith Whitney, John Mauldin, et.al. Typically, these financial astrologists weave together convincing, elaborate, grand guesses that extrapolate every short-term, fleeting economic data point into an imposing (or magnificent) long-term secular trend.

With all this talk of “double-dip” recession, I cannot help but notice the latest verbal tool implemented by every Tom, Dick, and Harry economist when discussing this topic… the word probability. Rather than honestly saying I have no clue on what the economy will do, many strategists place a squishy numericalprobability around the possibility of a “double-dip” recession consistent with the news du jour. Over recent weeks, unstable U.S. economic data have been coming in softer than expectations. So, guess what? Economists have become more pessimistic about the economy and raised the “probability” of a double dip recession. Thanks Mr. Professor “Obvious!” I’m going to go out on a limb, and say the probability of a double-dip recession will likely go down if economic data improves. Geez…thanks.

Here is a partial list of double-dip “probabilities” spouted out by some well-known and relatively unknown economists:

  • Robert Shiller (Professor at Yale University): “The probability of that kind of double-dip is more than 50 percent.”
  • Bill Gross (Founder/Managing Director at PIMCO): The New York Times described Gross’s double-dip radar with the following, “He put the probability of a recession — and of an accompanying bout of deflation — at 25 to 35 percent.”
  • Mohamed El-Erian (CEO of PIMCO):  “If you wonder how meaningful 25 per cent is, ask yourself the following question: if I offered you that I drive you back to work, but there’s a one in four chance that I get into a big accident, would you come with me?”
  • David Rosenberg (Chief Economist at Gluskin Chef): In a recent newsletter, Rosenberg has raised the odds of a double-dip recession from 45 per cent a month ago to 67 per cent currently.
  • Nouriel Roubini (Professor at New York University): “As early as August 2009 I expressed concern in a Financial Times op-ed about the risk of a double-dip recession, even if my benchmark scenario characterizes the risk of a W as still a low probability event (20% probability) as opposed to a 60% probability for a U-shaped recovery.”
  • Robert Reich (Former Secretary of Labor): According to Martin Fridson, Global Credit Strategist at BNP Paribas, Robert Reich has assigned a 50% probability of a double dip, even if Reich believes we are actually in one “Long Dipper.”
  • Graeme Leach (Chief Economist at the Institute of Directors): “I would give a 40 per cent probability to what I call ‘one L of a recovery’, in other words a fairly weak flattish cycle over the next 12 months. A double-dip recession would get a 40 per cent probability as well.”
  • Ed McKelvey (Sr. U.S. Economist at Goldman Sachs): “We think the probability is unusually high — between 25 percent and 30 percent — but we do not see double dip as the base case.”
  • Avery Shenfeld (Chief Economist at CIBC): “The probability estimate is likely more consistent with a slowdown rather than a true double-dip recession but, given the uncertainties, fiscal tightening ahead and the potential for a slow economy to be vulnerable to shocks, we will keep an eye on our new indicator nevertheless.” This guy can’t even be pinned down for a number!
  • National Institute for Economic and Social Research (NIESR) : “The probability of seeing a contraction of output in 2011 as compared to 2010 has risen from 14 per cent to 19 per cent.”
  • New York Fed Treasury Spread Model (see chart below): Professor Mark J. Perry notes, “For July 2010, the recession probability is only 0.06% and by a year from now in June of next year the recession probability is only slightly higher, at only 0.3137% (less than 1/3 of 1%).”

Listening to these economic armchair quarterbacks predict the direction of the financial markets is as painful as watching Jim Gray’s agonizing hour-long interview of Lebron James’s NBA contract decision (see also Lebron: Buy, Sell, or Hold?). Just what I want to hear – a journalist that probably has never dribbled a ball in his life, inquiring about cutting edge questions like whether Lebron is still biting his nails? Most of these economists are no better than Jim Gray. In many instances these professionals don’t invest in accordance with their recommendations and their probability estimates are about as reliable as an estimate of the volatility index (see chart below)  or a prediction about Lindsay Lohan’s legal system status.

I can virtually guarantee you at least one of the previously mentioned economists will be correct on their forecasts. That isn’t much of an achievement, if you consider all the strategists’ guesses effectively cover every and any economic scenario possible. If enough guesses are thrown out there, one is bound to stick. And if they’re wrong, no problem, the economists can simply blame randomness of the lower probability event as the cause of the miscue.

Unlike Wayne Gretzky, who said, “I skate to where the puck is going to be, not where it has been,” economists skate right next to the puck. Because the economic data is constantly changing, this strategy allows every forecaster to constantly change their outlook in lock-step with the current conditions. This phenomenon is like me looking at the dark clouds outside my morning window and predicting a higher probability of rain, or conversely, like me looking at the blue skies outside and predicting a higher chance of sunshine.

Using this “probability” framework is a convenient B.S. means of saving face if a directional guess is wrong. By continually adjusting probability scenarios with the always transforming economic data, the strategist can persistently waffle with the market sentiment vicissitudes.

What would be very refreshing to see is a strategist on CNBC who declares he was dead wrong on his prediction, but acknowledges the world is inherently uncertain and confesses that nobody can predict the market with certainty. Instead, the rent-o-strategists consistently change their predictions in such a manner that it is difficult to measure their accuracy – especially when there is rarely hard numbers to hold these professional guessers accountable for.

Economists and strategists may be well-intentioned people, just as is the schizophrenic trading advice of Jim Cramer of CNBC’s Mad Money, but the “probability” of them being right over relevant investing  time horizons is best left to an experienced long-term investor that understands the pitfalls of professional guessing.

Wade W. Slome, CFA, CFP®  

Plan. Invest. Prosper. 

www.Sidoxia.com

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, NYT or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

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15 Comments Add your own

  • 1. Hot Links: Punk is Dead The Reformed Broker  |  August 18, 2010 at 5:43 am

    [...] Wade Slome: Pay no attention to the pros calling for double dips.  (InvestingCaffiene) [...]

    Reply
  • 2. sidoxia  |  August 26, 2010 at 8:27 am

    8/26/10: After soft economic data over the last few weeks, wouldn’t you know, Roubini increases double dip probability to over 40%…shocker.

    Reply
  • [...] dip” (link). Some say it can’t happen, while others say it’s possible (link) or likely (link), while still others say we’re already in it (myself, Mish), but the common [...]

    Reply
  • 4. UIUCFIN  |  August 26, 2010 at 2:33 pm

    I agree with you the amount of forecasting is absurd. I also agree it is in many instances quite futile in the short term. However, I ask what would you like the alternative to be?

    If you looked out your window and saw dark clouds, and the night before you predicted a perfect day, would you still keep by your initial assessment?

    Updating ones view of the world as new information presents becomes available is the rational thing to do. I think you should focus your efforts on the futility of forecasting short term randomness and less on the logical side effects in attempting to do so.

    Reply
  • 5. sidoxia  |  August 26, 2010 at 4:24 pm

    UIUCFIN:

    You bring up some good points. Let me clarify a few more factors on why these strategists and economists drive me nuts:

    1). My contention is that we have more weather reporters than weather forecasters. My elementary school daughter could report the changing weather. I’m not saying there are not a small percentage of thoughtful long-term forecasters (e.g., I recently profiled Jeffrey Sachs), but the Wall street machine can’t make enough trading commissions and banking fees off of multi-year forecasts. They make their hay by predicting next week’s jobless claims number or tomorrow’s durable goods report.

    2). The arrogance and false precision that these economists claim to provide is laughable. Peter Lynch realized in the investing world, if you were right 6 out of 10 times, you were a hero. So many of these forecasters are fence sitters with dozens of caveats, making the possibility of being wrong almost impossible.

    3) Almost zero accountability for these economists. Unlike investors who put their money where their mouth is, CNBC parades the economist du jour (Roubini & Schiff in bear markets and Abby Cohen, et al in the bull markets), until they fall into oblivion when their forecasts are wrong.

    4) I applaud those long-term forecasters that stick their neck out and share non-consensus views, but very few survive in the 24/7 news cycle world we live in.

    For many of these forecasters, if they were so bright as they say they were, they would not be wasting their time sharing their views on TV. Rather, they would be investing their millions from appearance fees into betting on “double-dip” probabilities.

    The people I pay attention to are the long-term investors that have put their money where their mouth is, and have a long-term track record that they are held accountable for.

    OK…there. Now I can get off my soap box! :-)

    Reply
  • 6. Otto  |  August 26, 2010 at 6:16 pm

    I would really argue that the New York Fed Treasury Fed Model is an empirical model and therefore worth noting and worth adding to an informed debate. It is a set of data with meaningful correlations. I really disagree with you when you throw this into the same basket as the big global guru predictions that seem to fit themselves ad-hoc and post-hoc to the latest chart blips. Of course, I agree with you on your contempt for the big guru global predictions that seem to adjust themselves to the latest blips.

    I find that your statement that these forecasters have no credibility because they make their forecasts on television is really an ad-hominem attack that is logically invalid. You must accept the fact that there are people who know what they are talking about and are not in the market with lots of money. There is in fact no correlation to size of investment positions and correctness of these positions. You are only propagating a myth, the myth that the “big guys with the big money” are the true insiders who know what they are doing. There have been several academic economists and other trend researchers who have done very well in their predictions of the 2007-2010 credit disaster without having any money in the market. I guess people like you will need to learn (the hard way) that statistically size of position and correctness of forecast are truly orthogonal variables (which means they have no correlation to each other). Now it is true that rich people can last through dips and stubbornly hold on much better than small investors can, but that does not prove them right.

    Reply
  • 7. Brian  |  August 26, 2010 at 6:49 pm

    Since we don’t know what the future holds we can only assign probabilities to potential outcomes. That’s what successful investors do! They assign probabilities, make/hedge bets and try to keep our powder dry in the rain. What’s the alternative? Sit back and watch the world go by? Be a “long-term investor” who can only “hope” for 8% returns and tremble at the thought of going broke in the process? No thanks.

    Reply
  • 8. Bobbo  |  August 26, 2010 at 10:06 pm

    Look at the other side of the coin. How many professional economists saw the meltdown coming? Do a google search for “subprime overblown” and read through what all the professionals were saying in early to mid 2007. Fact is that sentiment is a big factor both in the market and the real economy, and sentiment is an erratic thing. What is the solution if it’s not listening to the competing arguments and trying to make an informed decision (to the extent that is even possible)?

    Reply
  • 9. Jim Haygood  |  August 27, 2010 at 4:51 am

    At the quantum level, atomic processes are probabilistic. At the macro scale, weather forecasts are probabilistic. And so are market forecasts.

    Black-and-white directional forecasts — or even worse, hard number forecasts; remember ‘Dow 36,000′? — are for amateurs.

    Probabilities are used because they best describe probabilistic processes.

    Reply
  • 10. Jack  |  August 27, 2010 at 7:25 am

    I have been reading J. Mauldin for quite a number of years and also paying attention to what D. Rosenberg, P. Schiff and N. Roubini were saying prior to the meltdown in 2007 and made my investment decisions such as dumping my shares and going 100% cash a few months before the blow-off top. I then went back into the share market at the end of 2008 and invested in gold miners and other resource companies for between 6 and 12 months. Again my decisions were driven by reading what some of the people on the list above were saying.

    I hapened to have a Ph.D. in the statistical decision theory and I think that I understand pretty well where they are coming from. I especially like the way D. Rosenberg uses empirical probabilities estimated from the past data. He often says that a particular phenomenon is e.g. 1 in a 100 event and also uses correlations. In the absence of other methods this sounds to me as a good way of guessing the future. At the end of the day it’s a statistical game and certain things repeat with some frequencies, some higher than the others.

    Reply
  • 11. MyGuess  |  August 27, 2010 at 8:01 am

    I think every expert and otherwise will agree that economy is very fragile. One or two big hits and it will go down. So if we do not mess with economy too much it will be in slow growth. Where odds really come in play is in estimating unknown: how many hard hits will come out of nowhere and hit a weak economy?
    Europe, China, Midterm election with Austerity measures, state and municipal crisis ….

    Reply
  • 12. Microsoft Makes Dividend Splash « Investing Caffeine  |  September 24, 2010 at 12:03 am

    [...] while strategists and economists fret about the possibilities of a “double dip” recession, in the interim there have been 179 companies in the S&P 500 index that have hiked [...]

    Reply
  • [...] to worry about? See 1963 article? Like the endless “double dip” economists before him (see also Double-Dip Guesses). As the evidence shows, Rosenberg’s anything-but-rosy outlook is a tad extreme and has been dead [...]

    Reply
  • 14. Flying to the Moon via Hyperinflation « Investing Caffeine  |  November 2, 2010 at 11:31 pm

    [...] was just a few months ago that pundits were talking about double-dip and deflation scenarios (see Double-Dip Guesses), and now on the brink of QE2, the pendulum has swung back to inflation fears. Printing excess [...]

    Reply
  • 15. Top 10 of 2010 « Investing Caffeine  |  January 7, 2011 at 1:00 am

    [...] Professional Double-Dip Guesses are “Probably” Wrong [...]

    Reply

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