The Folly of Economic Forecasting
How much is too much? At a Global Economic Forum, sponsored by the Chazen Institute in February 2014, Ruchir Sharma, Head of Emerging Markets and Global Macro for Morgan Stanley Investment Management, drew the boundary between sensible predictions and pure guesswork. Highlights of his comments:
The limits of forecasting: For most practitioners the right time frame for trying to make a forecast is possibly three to five years. The maximum is up to a decade. I think forecasts beyond that are completely meaningless.
Watch out for extrapolation: The most important mistake I feel people make in the game of forecasting is extrapolation. Basically a trends plays out for a while and then you draw a straight line and believe this is going to keep working for the next decade, two or three. That’s the single biggest mistake people make, whereas economics or investing teaches you that most trends are mean reverting. Meaning that you get a trend and, in 90 percent of the cases, those trends revert. There are very few exceptions.
The lifecycle of a nation: I’ve been an emerging markets investor now for 20 years. I saw the dark days in the 1990s when nobody wanted to touch emerging markets because there were serial crises from Mexico to Thailand to Russia to Argentina. Then you get a massive boom in emerging markets in the last decade. The peak year of 2007 was the only time that only three countries in the world reported a negative GDP growth rate. So you’ve got this massive convergence which took place.
What we’re seeing now is that a lot of the myths that were built over the last decade are being exploded one by one. One of those myths is that all emerging markets were destined to grow faster than the developed world. What happens instead is that when countries have good growth spurts, they get complacent. The policy makers stop reforming. All sorts of mistakes are made. Very few countries are able to keep reforming or doing well through cycles.
The best way to predict growth: For me it’s to be strictly on the lookout for the circle of life, which is that countries essentially follow four stages. The first stage is the boom. But the boom sows the seeds of complacency. Complacency often leads to crisis and reforms often take place only after a crisis. So today, when I’m trying to see which countries are going to do well, I’m on the lookout for where they stand on the circle of life.