Having a beef about forecasting and modelling

‘To have a beef’ means to have a complaint about something, to have a disagreement with someone, or to be dissatisfied with something. I’m dissatisfied with forecasting and modelling. This article explains why, and what it means to you.


First, let’s look at the difference between forecasting and modelling.

  • Forecasting = determining the expectations of future results
  • Modelling = taking a forecast’s assumptions and calculating the numbers using financial statements

The problem is that we can’t forecast or model what’s going to happen with any degree of certainty. Despite that, many sources seem to rely on forecasts and models, and use them to drive our lives.

What’s wrong with forecasting and modelling?

Forecasting and modelling can be useful, but they are based on assumptions which can change as soon as a single variable changes. In our opinion, assumptions have to be reasonable.

Fan-shaped assumptions

Forecasting and modelling are not an exact science (they are sometimes called ‘the dismal science’). Models are usually presented in a fan-shape to show the possible variation of outcomes:

  • The top line includes all the good assumptions and shows growth that will happen if everything is rosy and there’s a following wind
  • The bottom line includes all the bad assumptions and shows what will happen if everything goes pear-shaped
  • The truth will probably be somewhere in the middle

Here’s an old Bank of England fan chart to show you what they look like.

Fan chart

GDP projection based on market interest rate expectations

As you can imagine, small misjudgements at the start and throughout can lead to big errors at the end.

Faulty IMF forecasting

The International Monetary Fund (IMF) releases its global outlook twice yearly, showing its economic growth forecasts for almost every country.

Their latest forecast is that the UK economy will shrink by 0.6% while all the other G7 countries will rise. However, it has been reported that their figures were based on out-of-date and incorrect assumptions about energy costs.

I believe the differences between us and the other countries are tiny, it’s simply not true that everyone else is doing better than us, and the rankings will change. Energy costs are already lower than they were, so we’re not the shoddy little island that the IMF seems to think!

In fact, we’re regularly warned to ignore the IMF forecasts. Do a Google search of: “IMF track history of forecasting”. As you’ll see, the IMF has a terrible track history, so we have reason to be optimistic.

Faulty financial forecasts

Here are the forecasts made about the S&P 500 by all the big banks during 2021/2. At the start of the year, the S&P 500 stood at 4,778. All the predictions were way higher than what actually happened, as the S&P 500 ended the year at 3,853.

Everyone got it wrong! Their forecasts were all way off.

SP500 forecast(Data from Reuters 2021. Graph by our friends at Timeline.)

Myths about markets and recessions

When a recession is announced, some investors worry that the markets will shrink. But it’s too late by then. The markets incorporate recessions ahead of the announcement, and recover before the announcement that the recession is over.

See this graph from Dimensional which shows the US recession and stock performance during the global financial crisis, S&P 500 Index, January 2007– December 2010

Recessions

It’s not just Plan100 who says forecasting is dodgy

“There’s always going to be some error in those forecasts. This has been said forever. Just look at the Bank of England forecasts and their fan charts. The fan charts are absolutely huge, indicating that this is where we think GDP is going to be, this is where we think inflation is going to be, but the likelihood is that it might fall anywhere between these ranges and possibly even outside.”
George Buckley, chief UK economist, Nomura

“Very few people take any notice of what the IMF says in the business community or the financial markets”.
Julian Jessop, the economist who advised former PM, Liz Truss

“All macroeconomic forecasters are poor at predicting downturns.”
David Turner, head of the economics department at the OECD

“[Forecasts] fail to forecast strong booms, just as they fail to predict recessions… The ability to predict downturns remains dismal.”
Prakash Loungani, macro-economist at the IMF

Ah, but Plan100 does forecasting!

It’s true. We use our best endeavours to produce a long-term cash-flow forecast for our clients. We always discuss whether the assumptions are reasonable, yet any forecast can be hopelessly wrong.

Things change so fast that our forecast is probably wrong as soon as I walk out of the room. That’s why we sit down with our clients every year to see what happened last year and rerun the plan.

What this means to you

Don’t get hooked on forecasts and models. We can’t control the outcome any more than we can predict how well our next burger will be cooked.

The best thing to do is keep investment fund costs low, diversify broadly, ignore the media and stick to the plan.

Related reading

We’ve written similar articles before, including:

For the external sources referenced in this article, please check out:

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P.S. Remember the new tax year starts soon, so now’s the time to use your allowances. Please let us know if you’d like help with that.

Lance Baron

Certified Financial Planner (CFP) based in East Sussex, UK. We support people in Southeast England with more than £500K to invest by building a financial plan that will help them live the life they want… until age 100