Goldman Sachs found that economic forecasters aren’t quick to adjust their expectations. When forecasters overestimate an economic factor, they will continue to overestimate for several months before adjusting. Then, they will spend several months underestimating the factor.
Why do forecasters generally take so long to adjust their esstimates? The short answer? Future expectations must adjust for changes in current trends. Forecasts consider a variety of factors, each of which is constantly changing. A good forecast will consider the whole picture – not just a single trend.
Basing a forecast upon a single trend is called a projection. Projections are based on data from the recent past. So, if the trend in home prices this year is up 20% from the prior year, the projection would anticipate 2013 ending 20% higher than last year.
In contrast, a forecast takes 360 degrees of the market into consideration. For example, even though California mid-tier home prices were up by 20% as of May 2013, home sales volume has been slowing since November 2012. Historically, home sales volume movement precedes home price movement by about 12 months. Thus, home prices may begin slipping by the end of 2013.
But, but… a multitude of other factors are also taken into consideration, including:
• Job creation; interest rate movements; demographics with multiple facets; construction activity; and loan products.
And further still, to add more complications — forecasting is like keeping leashes on hundreds of hounds, all jerking in different directions, and trying to figure out where they’re taking you. A forecast cannot Ignore the animal nature of the hounds in its estimate (the fluid changes in culture and economics.) Ignoring the animal in us makes for a forecast that will diverge wildly from reality, sooner or later.
We know the market can never be fully rational for reason of those hounds on leashes. But people love to ask – how’s the market? What do you think will happen? We factor in as much data as we can, but just as important, we feel the mood of the market in our day-to-day activities. And we love to give our opinions. Just ask.
Excerpted from a recent article in First Tuesday.
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