Folly of the Forecasters


The Royal Bank of Scotland (RBS) says, “Prepare for a cataclysm.” But how much weight should we place on that forecast?

Yesterday, I saw that Andrew Roberts of RBS (Royal Bank of Scotland) put out a research note to the bank’s clients that essentially said clients should “sell everything” and suggested an economic cataclysm lies ahead. Want to get attention for your story? Just add the word “cataclysmic” to your forecast and that’s sure to do it.

BUT, should you listen to the Royal Bank of SCOTLAND (RBS) or the Royal Bank of CANADA (RBC)? After all, they’re both ROYAL banks.

Despite RBS’ dire prognostications, here’s what RBC had to say in their 2016 outlook:

The sell-off in many equity markets over the last few months has bolstered the long-term return potential for stocks. Even in the U.S., where stocks climbed slightly above fair value in the spring of 2015, valuations are back below the norm for periods of sustained growth, low inflation and low interest rates. Valuations are considerably more attractive in Europe and other global and emerging markets. As the Fed begins a new tightening cycle, we expect bond yields to rise, albeit at a gradual pace. That said, even a modest rise in yields from the current low levels will put significant pressure on bond returns. However, bonds offer stability through periods of higher volatility and, as yields rise, we expect to increase our exposure to fixed income . . . Our models continue to indicate that equities are likely to outperform bonds so we remain overweight stocks.

Of course, no one has a reliable crystal ball, and the prediction business is fraught with peril … on both the upside and the downside. For every dire forecast you read, you can almost certainly find another similar caliber organization with a prediction going the other way (and vice versa). I go back to March/April 2009, the turning point following the financial crisis, and most of the biggest firms and forecasters were still calling for considerable downside (Dow going from 6600 to less than 5000). Of course, most of them missed that one. The same with Goldman Sachs from 1982-1984. 1982 is when the longest bull market in history began, and Goldman continued to think it was not real until late ’84 / early ’85. Oops.

Finally, Andrew Roberts, the analyst at RBS who wrote the note warning of cataclysm, went on to say that US equities could fall 10% or even 20%. That wouldn’t be pleasant and, in fact, US equities are already down 11% from their all-time high, but neither that nor a 20% dip is what I would call a “cataclysm”; it’s actually pretty normal equity volatility, especially since we haven’t had a real twenty percenter since 2011 (and twenty percenters do happen, on average, about every five years – but not on a schedule, of course). Also, worth noting is that Andrews made essentially the same call in 2010.

Now, here’s something really enlightening (and entertaining) on the topic of bank and brokerage economic predictions: In 2002, the now-defunct brokerage firm, Bear Stearns, was involved in a hellacious lawsuit, filed by former client, Count Henryk de Kwiatkowski, who had lost hundreds of millions of dollars in a matter of weeks, having traded currency futures (on margin, no less) based on advice provided by Bear’s then chief economist (and former Federal Reserve Bank Governor), Wayne Angell. Essentially, the trade was based on Angell’s forecast that the US dollar would rise in late 1994 / early 1995. According to Bob Seabright, who wrote about this in greater detail on his Above the Market blog, at one point, the count’s traded positions totaled $6.5 billion (yes, Billion, with a “B”) and was 30% of the open interests in certain currencies on the Chicago Mercantile Exchange. As you might have gathered from the fact that there was a lawsuit, neither the forecast nor the trade worked out well for Count Henryk.

Jimmy Cayne, who was Bear’s CEO at the time, ended up testifying at the trial. Under oath and on the record, Cayne testified that Angell (again, Bear’s chief economist and a former Federal Reserve Bank Governor) was really just an entertainer on behalf of the firm and that such “entertainment” should never have been relied on, let alone be the basis for firm liability. (Refreshing honesty can arise in the most surprising of places.) Cayne went on further to explain that economists are right only about 35% to 40% of the time, and that a good part of Angell’s job was entertaining clients over lunches and dinners and making sales on behalf of the firm.

As Seabright pointed out, Cayne didn’t even try to make the case that Bear’s clients were entitled to “best efforts” or quality research . . . they were essentially paying for entertainment (and perhaps trade execution) but not for research, per se, or any expectation of fiduciary obligation. The count, as viewed from the firm’s perspective, was just collateral damage.

So that story, which still resonates to me as “business as usual” at the wirehouses, might be worth keeping in mind as you read the forecasts that no doubt will continue to litter the news as markets heat up and as we move further into this first month of a new year.

Epilogue: Bear Stearns lost the original trial with a commensurately high-dollar verdict, but alas, disappointingly for the count, the verdict was overturned on appeal.

As always, please don’t hesitate to reach out if you’d like to talk any of this over or if there is anything we can do for you.