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Topic: How To Invest

Avoid mixing together economic forecasting and stock investment decisions to make higher portfolio returns

economic forecasting

Combine economic forecasting and stock investment decisions and you could make some bad moves—including selling your best holdings too soon

Too much investor attention tends to be focused on economic forecasting and stock investment decisions. The fact is, forecasts provide little, if any, advantage when it comes to helpful stock market advice.

Studies by Dalbar Inc., a U.S.-based research firm, show that if investors do a lot of in-and-out trading—perhaps influenced by economic forecasts—they routinely make only about one-third of the return they could have earned with a simple buy-and-hold approach.

How Successful Investors Get RICH

Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor.

How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.

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Approach the coupling of economic forecasting and stock investment decisions with skepticism

Most experienced, successful investors feel skeptical, if not downright cynical, about economic forecasts, for three reasons.

  • Accurate economic forecasts are rare. They are undoubtedly rarer than profitable stock-market recommendations. There are simply too many economic factors interacting in too many ways. That’s why nobody guesses right every time, and even the best economists can be right on in one year and dead wrong the next.
  • Fame as an economist has little to do with forecasting skill. The fluctuations of oil provide a classic example of predictions having missed the mark. After oil prices got up above $145 a barrel about 11 years ago, many prominent Canadian and U.S. economists predicted that fast growth in India, China and other emerging economies practically guaranteed that oil prices would keep rising indefinitely. Common predictions had oil rising to $200 a barrel and beyond.

Instead of shooting up to $200, the price of oil plunged below $50 soon after. It is now not much higher than that at $58 (for West Texas crude), about a quarter of the confidently predicted high of just over a decade ago. The price of oil may well return to its previous highs. As oil alarmists frequently say, maybe they weren’t “wrong, just early.” However, if you had let the supposed inevitability of $200 oil serve as your guide to investing, you would have lost a lot more than the average investor.

  • Even when an economic forecast is right, it still may not offer helpful advice. The stock market anticipates economic trends much better than any economist, and moves up and down ahead of developing trends.

Investors mixing economic forecasting and stock investment decisions could make poor buying and selling decisions

When investors base buy and sell decisions on a short-term stock market forecast, they often experience notably poor investment results, or even lose money. This may come as a shock to them—that their predictions didn’t come true. It may have seemed to them that market trends, up or down, are easy to foresee. But in fact, nobody consistently foresees these trends. That’s why most investors hurt their returns if they let short-term stock market forecasts have much of an impact on their investment decisions.

That’s despite the fact that many investors may have guessed right about a coming trend at one time or another. Maybe they bought just prior to a big upswing, or sold in advance of a major slump. In the long run, however, these experiences may wind up costing them money. They may bet twice as heavily on the next trend they foresee, with more volatile stocks, only to discover their forecast was 100% wrong.

Link economic forecasting and stock investment decisions on gold and you lose money

After the gold-exchange standard ended in 1971, the price of gold, interest rates and inflation all started moving up. So-called “goldbugs” predicted that the worldwide switch to fiat money would bring great bouts of inflation and currency collapses. These views helped set off a boom in gold stocks and gold-related investments and collectibles.

I understood and sympathized with the goldbug theory. But I felt that most gold-related investments, including the highest-quality Canadian gold stocks, were priced as if the great inflation was a sure thing. Investors were willing to pay extraordinarily high prices because gold seemed like a special situation that deserved a huge premium.

Gold prices wound up making a huge gain between 1971 and 1980, thanks to the inflation of the 1970s, plus high interest rates. High inflation spurred interest in gold around the world, since gold has a reputation as a reliable inflation hedge.

The twin factors that helped push gold up from 1971 to 1980—high inflation and high interest rates—made investors wary of stocks and the economy.

Over the next couple of decades, downplaying or avoiding golds worked out well for my readers. Inflation continued in the 1980s and 1990s, although at much lower rates than the 1970s. We continued to make few if any gold stock recommendations. This time, my preference for stocks instead of gold paid off.

Now, though, we think that high-quality gold stocks look better now than at any other time in the past several years: For one, they’ve taken steps to cut their mining costs and expand their gold output; two, their shares have been poor performers since around 1990, while the rest of the market shot up. This makes them cheap despite their recent surge.

If inflation rises these next few years (a clear possibility), gold stocks will attract new interest

to keep pushing up prices. If gold-loving markets in Asia and other emerging markets continue to expand, consumer gold purchases will rise as well.

Use our three-part Successful Investor approach to make better investments

  1. Hold high-quality, mostly dividend-paying stocks.
  2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
  3. Downplay or stay out of stocks in the broker/media limelight.

Given their drawbacks, what kind of benefits do you think exist in economic forecasts?

What kind of connection have you noticed between economic forecasts and the movement of the market as a whole?

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