Can the Fed and Economists Forecast the Future? See This Startling Chart

Elliott Wave Financial Forecast Editors Kendall and Hochberg on economists, the Fed and forecasting

By Elliott Wave International

Business Talk Radio host Gabriel Wisdom recently spoke with Pete Kendall, Co-Editor of EWI’s Elliott Wave Financial Forecast. Their discussion included a crucial but rarely asked question about economists and the Federal Reserve. Here’s the relevant excerpt:

Gabriel Wisdom: “Ben Bernanke, the chairman of the Federal Reserve, says the economy is slowing but there’s faster growth ahead. Is he wrong?”

Pete Kendall: “Economists are extrapolationists. They tend to look at what’s happening in the economy and extrapolate that forward. So here we have a situation where not just Bernanke but economists in general are looking at… what they call the ‘soft patch’ and somehow contorting that into growth later in the year.

Pete’s startling reply flatly contradicts conventional wisdom. Most people believe that the Fed really is able to anticipate the economic future. After all, they’re the most “qualified.” But what do the facts say?

Pete’s Elliott Wave Financial Forecast Co-Editor Steve Hochberg recently included this eye-opening chart (from Societe Generale Equity Research) in his new subscriber-exclusive video, “Buy and Hold, or Sell and Fold: Where Are The Markets Headed in 2011?”

The red line in the chart is the S&P earnings, and the black line shows economists’ forecasts relative to those earnings. Here’s what James Montier, head of equity research for Societe Generale, said about it:

“The chart makes it transparently obvious that analysts lag reality. They only change their minds when there is irrefutable proof they were wrong, and then only change their minds very slowly.” (emphasis added)

That comment is spot-on. In 2002-2003, as you can see, earnings turned up despite economists’ forecasts for earning declines. It took them a while to “turn the ship around” and play catch-up with the trend.

Yet in 2007-2008, earnings turned down — despite the forecast by economists for continued increases. The devastating truth is that earnings did more than fall in the first quarter of 2008: they had their first negative quarter in the history of the S&P. As Steve said in his subscriber video, “Economists were wrong to a record degree” — and investors felt the pain.

So what’s the point? Economists do extrapolate the trend. That approach works fine, until it doesn’t­ — and you’re on the hook.

Elliott wave analysis never extrapolates trends — it anticipates them. The Wave Principle recognizes that markets must rise and fall — and that they unfold according to changes in investor psychology, in a way that is patterned and recognizable.

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