Why should the market listen to economic forecasts?
Broad Street in Manhattan. Source: Wikimedia
The short answer is, to make predicting the weather look easy. But seriously, the market depends on earnings, earnings depend on revenues, and revenues depend on the economy. All else being equal, a strong economy should lead to strong earnings and a strong equity market, which feeds back to the economy.
But all else is never equal. Good economic news can become bad market news when filtered through the Fed. If the economy is too strong, they’ll raise interest rates aggressively, which means a higher discount rate applied to stock dividends, and lower stock prices. Finance can outweigh economics, when it comes to valuation. Or a weaker economy could allow for cheap financing and aggressive mergers and acquisitions – leading to a stronger stock prices. Investment outweighs finance. Except when an aggressive CEO overpays in a bidding war and the winner becomes a loser. Psychology wins but then it loses.
N-dimensional hypervolume. Public Domain. Source: Matlab, Wikimedia
The investment business is a multi-dimensional chess game in which the economy operates on one of the more important planes, but only one of those dimensions. The others include finance, psychology, diversification, animal spirits, taxes, the Fed, the dollar, and other crucial variables. This kind of environment does make predicting the weather seem easy.
Which brings up a story about weather forecasts during World War II. Admiral Halsey’s staff once told him that Pacific storm patterns were impossible to predict at that time of year. "Of course the forecasts are useless,” Halsey replied. “But we still need them for planning!"
Douglas R. Tengdin, CFA
Charter Trust Company
“The Best Trust Company in New England”