The last few years have been anything but predictable. This is tough to stomach for investors; with markets volatile our investment portfolios have been constantly moving up and down.

Yet uncertainty is an inescapable part of investing, one which investors are compensated for accepting. Throughout all of these uncertainties, markets continue to deliver, with the S&P 500 nearly at all-time highs following a poor start to 2022.

During 2020 we reckoned with COVID, lockdowns and economies grinding to a halt. This year also brought negative oil prices for the first time in history.

In 2021 we had the Gamestop fiasco, Crypto crashes, the Suez Canal obstruction and the beginning of the Evergrande property crisis in China.

2022 brought the Ukraine invasion, the assassination of Shinzo Abe, Queen Elizabeth's passing, Liz Truss's record short 44 days in office and the beginning of extensive rate hikes.

The start of 2023 also delivered, with the collapse of Silicon Valley Bank, First Republic Bank and Signature Valley Bank. We continue to wrestle with inflation and the rising interest rates.

And yet markets trudge on. It would have been impossible to predict these events at the beginning of each year. History has shown it is also impossible to predict how they may impact markets. Luckily, with a diversified investment strategy, we don't have to make predictions. We can sit tight and be assured that markets deliver long-term.

Despite this, predictions make great headlines and articles. It is important to see these as entertainment and not investment information. Even the most knowledgeable commentators cannot accurately predict the future.

The article below is by Dimensional's Jim Parker. As the Australian financial year comes to a close, he revisits the predictions made in the media for the previous year. Unsurprisingly, it has proven tough to hit a moving target.

Cracks in the Crystal Ball

By Jim Parker Vice President

A standard media device at the start of a financial year is a “lookahead” on the outlook for the coming 12 months. As a reflection on the anxieties of the day, these articles are usually reasonably accurate. But as a forecast of the future, not so much.

The financial year outlook articles are put together by journalists based on interviews with market economists and analysts, who are asked to provide estimates for economic growth, inflation, interest rates, shares, bonds and currencies in a year’s time.

The resulting stories are usually an interesting read. But there is a fundamental problem with this approach in terms of its reliability: The economists’ forecasts rest on a whole bunch of assumptions that can quickly exceed their use-by date when events change or when at least one of the variables undershoots or overshoots their expectations.

One only has to look at the past three years or so to see examples. Carefully made projections for 2020 were made quickly redundant by Covid. Two years later, Russia’s invasion of Ukraine upended another set of economic and market assumptions. And remember when we were told that the upsurge in inflation was likely to be a transitory phenomenon?1

Making accurate predictions is tough at the best of times, but nailing year-end forecasts for interest rates, shares, currencies and other variables in the face of wars, pandemics and the biggest inflationary breakout in four decades is a nigh-on impossible ask.

Just how hard can be seen by looking back at the forecasts published in the Australian media this time a year ago.

The Conversation academic website each year surveys a panel of academic, market and industry economists for their outlook for a series of economic and market variables for the coming year. In mid-2022, the panel comprised 22 experts.2

The consensus forecast for the Reserve Bank of Australia’s official cash rate was a rise from its then rate of 0.85% to peak at 3.1% by August this year. Well, we’re now in July and the rate is already at 4.1%, with market expectations of one or two further increases by year end.3

For headline inflation, the panel on average expected it to moderate to 4.8% by the end of the 2022/23 financial year. The most recent monthly inflation indicator for May from the Australian Bureau of Statistics had annual inflation at 5.6%.4

On the economic outlook, the panel saw a 40% chance of a recession in the US in the coming two years and a 20% chance of one in Australia, most likely starting in August 2023. While the US economy has slowed, authorities there recently upgraded estimates of GDP growth for the first quarter of this year from 1.3% to 2.0% - still a fair way from recession.5

In Australia for the same period, annual GDP growth was 2.3%, a marked slowdown from 2.7% at the end of 2022, but still well short of recession.6

Unemployment was also seen by the panel as likely to increase over 2022/23 from 3.9% to 4.2%. In actual fact, the jobless rate has fallen in that period to be at 3.6% by May this year.7

On financial variables, the consensus was a slow and modest recovery in the Australian dollar to around 72 US cents. In fact, the currency declined over the financial year from around 69 US cents in mid-2022 to close to 66 cents by June 30 2023.8

On equity markets, the panel expected the Australian share market to fall 2% over the financial year. The reality was the Australian market, as measured by the S&P/ASX 300 index on a total return basis, climbed by more than 14% in 2022/23.

What happened? The economists undershot their expectations for inflation, GDP growth, interest rates and share markets, while overshooting expectations for unemployment and the Australian dollar. In essence, they underestimated the strength of the economy.

To be fair, it’s a tough business, forecasting, even for the experts. So much can go wrong if one variable (like inflation in this case) turns out to be stickier than assumed. But it’s a reminder to the rest of us not to put too much weight in these articles about the year ahead for economies and markets.

It’s also a reminder that basing your investment strategy on these forecasts is unlikely to be a successful or sustainable strategy. Instead, accept that the market already does a pretty good job of incorporating all those opinions and expectations for the future and that as events occur, market prices will change.

No-one can predict the future and there will always be uncertainty. The potentially higher returns on offer from shares and other assets are the trade-off for the uncertainty.

At the end of the day, having an appropriate asset allocation for your own risk appetite and personal goals, staying diversified and remaining disciplined are the best alternative to relying on a cracked crystal ball.

FOOTNOTES

1‘Recent Trends in Inflation’, RBA Governor Philip Lowe, 16 November 2021.
2‘How the Conversation’s Panel Sees the Year Ahead’, The Conversation, 30 June 2022.
3ASX 30-Day Interbank Cash Rate Futures Implied Yield Curve, as of 30 June 2023.
4Monthly Consumer Price Index Indicator, Australian Bureau of Statistics, 28 June 2023.
5‘US Weekly Jobless Claims Post Biggest Drop in 20 Months as Economy Shows Stamina’, Reuters, 30 June 2023.
6Australian National Accounts, Australian Bureau of Statistics, 7 June 2023.
7Labor Force Australia, Australian Bureau of Statistics, 15 June 2023.
8Historical Exchange Rate Data, Reserve Bank of Australia.