Many investors make their investing decisions based in part on economic forecasts. This style of investing is called “top down” investing. The idea is to take the consensus economic forecast and allocate capital to sectors and industries that will fare the best under the forecasted economic numbers.
The problem is that economic forecasts can unravel quickly. For example, in December 2006, the Business Week Economic Forecast Survey of 2007 called for total economic growth of 2.6% and the Q4 2007 economic forecast has a consensus estimate of 3.0% economic growth. In actuality, it turned out to be 0.6% in Q42007and many economists and investment strategists began to wonder whether or not the economy had already entered recession. Some were of the opinion that this was a rough patch and interest rate cuts and certain data points led them to believe that 2008 would see the economy mend quickly. As we now know, with the benefit of history no doubt, 2008 was a year which saw the seemingly “unthinkable”.
Price of crude oil before and after the start of the Egyptian unrest (click image to enlarge)
Last year, economic predictions ranged from inflation to deflation and back to inflation. The point is that in today’s global economy, the global economy can change seemingly on a dime. If we look at the most recent unemployment figures in the US, January unemployment was measured at 9% – yet just a few short months ago the economic forecasts were by and large of the opinion that unemployment would not come down to these levels until next year. To be sure, they could just as easily be revised higher – but the economy is beginning to produce jobs and small businesses are starting to indicate they will be looking to hire again.
A little over a week ago, crude oil had begun to taper its rise, and investors were beginning to put pressure on many of the oil related stocks. No sooner had this shift begun that the Egyptian unrest that followed on the heels of Tunisian riots sent oil prices scurrying higher. Thus, on a dime – a country that surely did not factor into most any economic forecaster’s predictions has ushered in a degree of uncertainty. For example, some investors are worried that the Suez Canal and pipelines that cross the Egyptian desert will be interrupted – causing major oil disruptions. If this (at this point highly unlikely event) were to occur, what would the impact be on the global economy? It cannot be predicted because such events do not lend themselves to be easily modeled into an economic equation.
In 2009, protests in Iran led many to conclude that perhaps the Iranian regime would be the first to fall. Egypt hardly received any mention as a country where political unrest could cause “regime change”. However, at this point it seems as if Egypt will have a new leader- after almost 30 years. Now, reports of popular anger are coming from Jordan and Syria. While Jordon and Syria are not significant economies in the global sense, events there can impact the economic outlook in either good or bad ways.
Even before events in Egypt came to the front, high oil prices were helping to fan the inflation levels in many of the emerging markets. Recent data had been indicating that the oil import bill of many of these countries was starting to have an impact on these economies. Now an event out of left field could cause investors to rethink things.
The longer this unrest continues without a clear end game in sight, investors might hope that the economic forecasters have an eraser handy to make corrections to their economic assessments. For top down investors, this should serve as a lesson that investing is hard enough – trying to base it in large part on getting an economic forecast correct on top of everything else is an imprecise exercise even at the best of times. In investing, consensus of any sort should never be interpreted as a reason for action. Often times, it has proven to be a reason to be cautious.
The central idea of the above mentioned points is not to put a good or bad spin on the events from an economic or investment perspective. They could just as well be mere distractions in the big scheme of things. Rather, it should serve as a reminder that sometimes the unknown and seemingly random event can dent the armor of consensus thought.
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