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Why economists make astrologists look respectable

05 May 2023

Central banks are making headlines again this week, but should investors care?

By Jonathan Jones,

Editor, Trustnet

This week the Federal Reserve took centre stage, raising interest rates by 25 basis points to 5 to 5.25%, the base rate’s highest level since September 2007, as part of the most aggressive set of increases since the 1980s.

The consensus view among market commentators is that this is the last hike in the current cycle, even though Fed chair Jerome Powell has refused to rule out further increases.

Some analysts went even further, anticipating that rates would be cut before the end of the year, with one saying that the market pricing suggests there could be several cuts, starting as early as September.

This was not the case this time around, much to the chagrin of the market: the S&P 500 index was off 0.8% in early trading on Thursday.

The European Central Bank (ECB) also raised rates this week by 0.25 percentage points, though this was less than the 0.5 percentage point hike from the previous meeting.

Domestically, all eyes will undoubtedly turn to the Bank of England next week, with AJ Bell investment director Russ Mould noting that markets are pricing in a quarter-point rise at this meeting to 4.5%, followed by a similar rise in August and one more in September.

“That is expected to be the peak, with 0.25 percentage point rate cuts currently expected in February and March 2024,” he said.

Yet investors are often warned against trying to predict the future. I wrote in this column last week that many are seemingly making binary bets following the announcement of weaker-than-expected US GDP figures, which some analysts suggested could stop the Fed from raising rates for fear of causing a recession.

So are the market makers right? As I have said before, I have no idea. And when reading the prognostications of economists, it is worth remembering this quote from Canadian-American economist John Kenneth Galbraith: “The only function of economic forecasting is to make astrology look respectable.”

A quick search online will find many other quotes poking fun at those who make economic forecasts. My personal favourite: “An economist is an expert who will know tomorrow why the things he predicted yesterday didn’t happen today,” by Laurence J Peter.

But investors face a tough decision. Sven Schubert, senior investment strategist at Vontobel, wrote this week that, in a world that is more unpredictable than ever, portfolio construction gets more complicated.

“A more active investment strategy is required,” he concluded, noting that “buy-and-hold strategies will not work the same way as they used to”.

Even so, they may be the best bet for anyone unwilling to make binary calls. After all, the future is murky, but hindsight is 20-20.

To borrow one final cliché from economist John Maynard Keynes: “It is better to be roughly right than precisely wrong.”

Preparing for a range of outcomes via buy-and-hold strategies may not be the flashy pick, but is less likely to be spectacularly wrong and could prove incredibly right. This technique is by no means fool-proof, but it feels better than justifying losses based on the outcome of central bank decisions.

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