When Doves Cry . . . Let’s Dance

It is not often one gets the chance to combine a discussion of the media and central banking with the music of 80s pop icons.

While the Federal Reserve is certainly a credible institution, often the media’s reactions to Fed’s forecasts and policy decisions seem like entertainment.

Last week we posted about a few market indicators that indicated both a real and potential pickup in volatility. Usually that is shorthand for a correction, but in reality, the way we measure volatility and the way we explain it means sharp movements both up and down – it is deviation from the average. So what we have seen is market uncertainty, but perhaps not yet a more permanent correction.

This week the minutes of the most recent Federal Reserve policy meeting were released, and they indicated that the Federal Open Market Committee was more concerned (i.e. ‘dovish’) with a strong dollar and a weakening global outlook. And that dovish concern is interpreted as an expectation that the Fed will continue its stimulus policies for a longer period: lower rates, more liquidity and so forth. The markets initially moved higher on this “bad news is good news” information. The bad news is that the global macroeconomic outlook is weakening and the dollar is too strong. The good news is that the Fed should keep pumping stimulus into the economy, which is good for stocks and all kinds of risk assets.  Noticed any construction going on near you?

It is exactly this kind of hither and thither, he-said she-said, Fed-speak parsing that we try to ignore at KilterHowling. Incredibly well paid and presumably smart economists on Wall Street attempt to forecast the direction of interest rates and the next utterance from the Fed and get it wildly wrong. Over and over and over. Occasionally someone gets it right but, as the old saying goes, even a broken clock is right twice a day. Economic forecasting inaccuracy has been studied by many: here, here and here. Below is a chart showing the percentage error in economic output forecasting made by the CBO, the Administration and a collection of 50 ‘Blue Chip’ forecasters. Herd much?


Phil Tetlock, at UCLA, has made a career studying the defenses used by professional forecasters – whose accuracy is routinely shown to be worse than chance! Here’s a quick read on that.  It has been said that the only function of economic forecasting is to make astrology look respectable.

The behavioral finance writer James Montier, who has managed to make a career slaying the Wall St. prediction machine while still being employed on Wall Street, penned a fantastic piece years ago titled “The Seven Sins of Fund Management”, the first chapter of which is “The Folly of Forecasting: Ignore All Economists, Strategists and Analysts”. Why is it so hard to predict a Fed move or an economic statistic either inside of or outside of the Federal Reserve? Because the future is unknowable, and even patterns that repeat themselves only tend to do so over long, not short, periods of time. The chart below attempts to illustrate this phenomenon. Think of “The Data” as estimates of, say, GDP growth. And ‘The Trend’ is the actual number we see.


So if we can’t forecast the future, how can we build the portfolio for the market moves of the recent past, which saw six of ten days move more than 1%, including the last four S&P500 trading days (ended 10/9/2014) which were: +1.1%, -1.7%, +1.8%, -2.1%. What to do in this situation?

First, we don’t focus on a week or even a month at a time. We focus on the long-term and build portfolios that weather market volatility by managing and avoiding downside risk. We employ disciplined processes – such as the KH Global Tactical model where we do not argue with ourselves or try to summarize what the various prognosticators tell us. We utilize objective trend information in the market and act on it. If a bullet is headed my way I want a Kevlar vest, not a panel of experts predicting the accuracy of the shot.

 “We really can’t forecast all that well, and yet we pretend that we can, but we really can’t.” – Alan Greenspan

We also believe in our team of fund managers and the rigorous process by which we find them.  These managers may use a tactical process but are more often value-oriented investors which couples well with our in-house Global Tactical portfolio.  These managers are heavily invested alongside their clients, just as we are with ours.  We also like managers who are located away from Wall Street, or who have nontraditional team structures.  Managers in our portfolios take contrarian views, have the ability to hold cash if so inclined, and demonstrate the (very) unique ability to participate in up markets while minimizing participation in down markets.

I am a news junkie. It is fun to read about the Fed, to watch macroeconomic events unfold, to observe the strength and weakness of job growth, the global economy, etc. But none of that informs a consistently accurate forecast of what is going to happen next.  From Prince to David Bowie to even the Wall Street Journal (dare I say), it is all just entertainment.  Sometimes When Doves Cry the best response is … Let’s Dance.