It's folly not to take account of mysterious Factor X
EXPERIENCE is a patient teacher. The many years I have spent in attempting to forecast investment markets and the economy have taught me several key lessons.
One is that we must allow that markets and business conditions move via cycles rather than with steady rates of growth. And this is for a powerful reason: cycles in business conditions and markets are three-parts crowd psychology.
When other people feel good, their enthusiasm to spend, borrow and invest spreads; we want to join in too. Moods of gloom can become pervasive, too, as most of us are affected by others' reluctance to spend, borrow and invest. Governments and central banks at times aggravate the cycles in the economy and investment markets by running their economic policies on the "too much, too late" principle -- tightening policies when a boom is about to end and easing policies when a weak economy is about to recover of its own accord.
Admittedly, economic policies are mostly managed better these days. But as the US sub-prime crisis shows, there are still times when a major problem is ignored for a long time and then every possible solution is thrown at it.
The biggest challenge in forecasting is to be on the lookout for important turning points in business conditions or investment markets. For 2008, the prospects are that we will see a significant slowing in economic growth in the US and Australia, the return of cautious moods in the share market and house prices. Second, we must allow that shares, interest rates, property and exchange rates often develop a momentum, up or down, that moves them more than the fundamental influences driving them would require.
All markets "overshoot". And there is something about the workings of foreign exchange markets that cause exchange rates to overshoot more than other prices. In the early part of this decade, an Australian dollar traded for US48c; it recently exchanged for US94c.
The third great lesson from history is that each year has its Factor X. Factor X is the powerful influence that was not even thought about when the year began, but which came out of the woodwork, as it were, to have a big effect on investment markets and business conditions. I've long been a fan of Factor X, and as my list shows, I've been selecting a Factor X each year since 1982. Factor X can be positive (such as the resilience of the Australian economy in 1998 despite the Asian economic crisis and, in 1991, the sustained collapse of inflation) or horrible (the terrorist attacks of September 2001).
Factor X can be global (the collapse of communism in 1989) or uniquely Australian (Paul Keating's comment on national radio in 1986 that Australia risked becoming a banana republic unless it reformed, or the substantial change in superannuation arrangements in 2006).
Acknowledging Factor X is not a cop-out from trying to predict the future. Instead, it is a necessary reminder of the role of uncertainty, the need to watch for unexpected news (good or bad) that will change the likely course of the economy or markets, the importance of risk management and the benefits of sensible diversification. What was Factor X for the year now ending?
My list of the finalists, in no particular order, include: the crisis in sub-prime debt that hit the US and world markets over the second half of the year; the tripling in China's share market; the sustained boom in commodity prices (funny thing, but everyone now wants to be invested in the "old economy" that was so derided in the late 1990s); the decoupling from the US economy of the economies of the western Pacific, including Australia; the huge moves in financial markets around the time of the mini-panic of mid-August; the Reserve Bank's increase in interest rates 17 days before the federal election; and Kevin Rudd's proposing fewer tax and spending giveaways than John Howard during the election campaign in November.
In my view, the award of Factor X for 2007 goes to the increase in interest rates announced by the Reserve Bank two and a half weeks before election day. And this is a move with longer-term consequences, as it puts beyond doubt the Reserve Bank's independence and its desire to restrain inflation, however unpopular its moves. I am sure the lesson will not be wasted on the newly installed Rudd government. None can say what Factor X will be in 2008. Indeed, any Factor X that is successfully predicted cannot be a Factor X.
Wise investors and businesses will allow that next year will have its Factor X -- and build a sensible diversification into their investment portfolios and risk management into their businesses.
source; http://www.theaustralian.news.com.au/story/0,25197,22886605-5001942,00.html
One is that we must allow that markets and business conditions move via cycles rather than with steady rates of growth. And this is for a powerful reason: cycles in business conditions and markets are three-parts crowd psychology.
When other people feel good, their enthusiasm to spend, borrow and invest spreads; we want to join in too. Moods of gloom can become pervasive, too, as most of us are affected by others' reluctance to spend, borrow and invest. Governments and central banks at times aggravate the cycles in the economy and investment markets by running their economic policies on the "too much, too late" principle -- tightening policies when a boom is about to end and easing policies when a weak economy is about to recover of its own accord.
Admittedly, economic policies are mostly managed better these days. But as the US sub-prime crisis shows, there are still times when a major problem is ignored for a long time and then every possible solution is thrown at it.
The biggest challenge in forecasting is to be on the lookout for important turning points in business conditions or investment markets. For 2008, the prospects are that we will see a significant slowing in economic growth in the US and Australia, the return of cautious moods in the share market and house prices. Second, we must allow that shares, interest rates, property and exchange rates often develop a momentum, up or down, that moves them more than the fundamental influences driving them would require.
All markets "overshoot". And there is something about the workings of foreign exchange markets that cause exchange rates to overshoot more than other prices. In the early part of this decade, an Australian dollar traded for US48c; it recently exchanged for US94c.
The third great lesson from history is that each year has its Factor X. Factor X is the powerful influence that was not even thought about when the year began, but which came out of the woodwork, as it were, to have a big effect on investment markets and business conditions. I've long been a fan of Factor X, and as my list shows, I've been selecting a Factor X each year since 1982. Factor X can be positive (such as the resilience of the Australian economy in 1998 despite the Asian economic crisis and, in 1991, the sustained collapse of inflation) or horrible (the terrorist attacks of September 2001).
Factor X can be global (the collapse of communism in 1989) or uniquely Australian (Paul Keating's comment on national radio in 1986 that Australia risked becoming a banana republic unless it reformed, or the substantial change in superannuation arrangements in 2006).
Acknowledging Factor X is not a cop-out from trying to predict the future. Instead, it is a necessary reminder of the role of uncertainty, the need to watch for unexpected news (good or bad) that will change the likely course of the economy or markets, the importance of risk management and the benefits of sensible diversification. What was Factor X for the year now ending?
My list of the finalists, in no particular order, include: the crisis in sub-prime debt that hit the US and world markets over the second half of the year; the tripling in China's share market; the sustained boom in commodity prices (funny thing, but everyone now wants to be invested in the "old economy" that was so derided in the late 1990s); the decoupling from the US economy of the economies of the western Pacific, including Australia; the huge moves in financial markets around the time of the mini-panic of mid-August; the Reserve Bank's increase in interest rates 17 days before the federal election; and Kevin Rudd's proposing fewer tax and spending giveaways than John Howard during the election campaign in November.
In my view, the award of Factor X for 2007 goes to the increase in interest rates announced by the Reserve Bank two and a half weeks before election day. And this is a move with longer-term consequences, as it puts beyond doubt the Reserve Bank's independence and its desire to restrain inflation, however unpopular its moves. I am sure the lesson will not be wasted on the newly installed Rudd government. None can say what Factor X will be in 2008. Indeed, any Factor X that is successfully predicted cannot be a Factor X.
Wise investors and businesses will allow that next year will have its Factor X -- and build a sensible diversification into their investment portfolios and risk management into their businesses.
source; http://www.theaustralian.news.com.au/story/0,25197,22886605-5001942,00.html
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