CIRCUIT BREAKER. The fine art of forecasting

It was six months since he joined Business Bugle and Ashutosh was already a seasoned journalist.

Summoning him, his editor said, “We’ve got an edition to run, boy. I know there’s no actual business happening. All the company chiefs and market gurus are probably in pubs swigging Single Malts. But ask them how 2015 will turn out. That’ll get you some good sound bytes.”

Ash quickly googled ‘Sensex target’. Bull’s-eye! Most brokers had already put out their 2015 targets. Their forecasts for the Sensex ranged from a precise 32,980 to 33,500 points, by December 2015.

“Boring,” thought Ash. “That’s just a 20-22 per cent gain in a year.” Knowing his editor always went for man-bites-dog stories, he looked for a bearish analyst with a Sensex target of, say, 15,000. But he couldn’t find a single one.

During all this googling though, a Sensex forecast with an extra zero caught his eye. “Sensex @ 100,000 by 2020,” said the report.

He called up the analyst, who had it all mapped out: “See, we expect the Indian economy to grow at 6 per cent next year in real terms. If you assume 7 per cent inflation, that takes you to 13 per cent nominal growth. Everyone knows India Inc’s profits usually grow faster than the economy, so it may be 15 per cent in 2015. Now, given the low base, profits may accelerate to 20 or 25 per cent over the next four years. If that happens, you have the Sensex at a lakh by 2020. It’s not far-fetched.”

Ash found these calculations daunting, but did some quick maths. “Epic! That means stocks will multiply my money four times in six years. Maybe I should clean out my bank account and park it all in Sensex stocks?”

He decided to run this past Ashokbhai, the paper’s veteran and cynical Markets Editor, over a cup of cutting chai.

“Kid, do you know at what rate Sensex company profits have grown in the last six years? 8 per cent. Anyway, who told you the Sensex has anything to do with earnings? It’s all about how much money FIIs put in. 2020 toh door ki baat , no one even knows how much will come in next year, without any QE,” he said, prompting Ash to revise his investment plans.

Now sceptical about Sensex predictions, Ash filed the story and decided to look into crude oil which he knew had crashed by 50 per cent in six months.

He thought falling oil would make for a cheerful year-end read. After all, his dad was always going on about giving his bike a rest and taking the metro.

But crude oil forecasts were much more complicated than Sensex forecasts. The predictions from big global banks ranged from $59 to $85 a barrel for Brent crude in 2015.

Every report backed up its prediction with erudite analysis involving rising US shale oil production, the cost of fracking, West Asian politics and the fate of China. One even made a nice case for oil at $20, explaining how Saudi Arabia was deviously using ultra-low oil prices as a weapon to systematically decimate its political enemies.

Confused by all the technical stuff about fracking and whatnot, he called up his pal from B-school who now worked at an investment bank. The bank was well known for its crude oil forecasts, having propounded the ‘peak oil’ theory in 2008 and projected that oil would head to $200 a barrel. Now their forecast was for $85 due to a global supply glut.

“Every analyst out there has a forecast on crude oil and they range from $20 to $85. Which one should I use, dude?” he asked desperately. “Pick any one,” said the budding investment banker casually. “This is only this month’s forecast for 2015. We will all be revising it in January.” After coming up with the peak oil theory, he explained, most forecasters had egg on the face when oil slumped to $40 the same year, hit by the global credit crisis.

Thereafter, some made multiple forecasts through the year, fine-tuning them with ‘changing global dynamics’. That’s why, as oil prices fell, so many analysts were slashing their targets.

“But I thought forecasts were supposed to pre-empt events, you know? Not react to them?” said Ash. “Don’t you know what Keynes said? As facts change, you have to change your views,” retorted his friend.

Deciding to do some legwork, Ash hurried to the venue of the Global Investor Summit, where a renowned economist and professor from the US was delivering an address.

The professor was already midway into a stirring speech about how China was a spent force. He highlighted a truckload of problems with the Chinese economy, stating confidently that it would collapse very soon. He made a strong case.

For one, he argued, there is China’s $3.5 trillion shadow banking system which is coming apart with stricter regulation. Then, there is poor job growth. Shocking, isn’t it, that China created less than 3 million jobs in 2013? And there is this big credit-funded real estate bubble which, as China cuts interest rates, could implode. Therefore, the China story is over. It is to India that all global investors must now turn, to park all their excess money.

The audience, which loved the China-bashing, erupted into wild cheers and later mobbed the professor.

Ash had just one question. “Sir, how can you really say that India is better than China? China is a $9 trillion economy and we are $2 trillion. IMF predicts that China will grow at 7.1 per cent in 2015, but India will grow at 6.4 per cent. And some of these problems that you mentioned sir, we seem to have them in India too. We have these unlisted firms which have collected crores and vanished. Our banks have lent to all these airlines and infra projects which are going under. And we don’t even know how many jobs we are creating in India because we don’t have the data”.

The professor bristled. “You obviously don’t know much about China, young man. How long have you been in journalism?” he asked haughtily. “Six months,” mumbled Ash.

“Don’t you know that you can’t really believe the numbers from China? I know, because I’ve been predicting the collapse of China since 2000,” said the professor, quite unabashedly.

As Ash handed in his final story, he realised that he wasn’t much wiser about how 2015 would turn out.

But he had learned the three golden rules of making good forecasts: Make dramatic predictions, don’t worry about the numbers. Keep changing them to go with the flow. Or simply stick doggedly to your forecast for years.

One day, it will eventually come true.

COMMENT NOW