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January 24, 2015

Oil Shows the Folly of Forecasts

By Charles Rotblut

Since I received many emails regarding last week’s commentary, on TurboTax in particular, I wanted to give a quick update. Dissatisfied TurboTax customers may be able to get a free upgrade by contacting Intuit. A spokesperson at Intuit told me they will work with customers who have concerns about the software changes on “a case-by-case basis.” A few AAII members said the Schedule D form can be found in the Deluxe version of TurboTax, though Intuit says TurboTax Deluxe does not “cover” stocks, bonds and other investment income. The Kansas City Star says H&R Block is giving free copies of its tax software to dissatisfied TurboTax users, though I have not confirmed this. If you want to try, send a copy of your receipt to SwitchtoBlock@hrblock.com.
Whenever Mr. Market wants to change something, he can turn the dials pretty swiftly and cause prices to move significantly. The speed and the magnitude of the changes are often greater than many investors realize while the price adjustments are occurring.

Oil provides a good example. At the end of last June, oil traded at $105.37 per barrel. Over the next three months, the price declined to $91.16. Then, in the fourth quarter, oil plunged by more than 41% to $53.27 on December 31, 2014. Oil has continued to fall this month, trading at $46.50 per barrel today. Put another way, oil has fallen by 56% since the end of June and 49% during the 16-week span starting at the end of September.
As a driver, I’m happy. It was great to be able to fill up my wife’s SUV for $25 last week. (She drives a Hyundai Santa Fe.) As an investor, I’m cognizant of the impact the drop has had on shares of energy companies and energy funds. I’m even more cognizant of how this move reveals the folly of forecasters.
Let’s go back to last June. Twice a year, Barron’s holds a roundtable discussion of Wall Street experts to discuss their outlook for the financial markets and investment ideas. During last summer’s roundtable, fund manager Mario Gabelli recommended oil service company Weatherford International (WFT) and money manager Scott Black listed exploration and production company PDC Energy (PDCE) among his picks. In January 2014, Goldman Sachs’ Abby Joseph Cohen responded to a question about her firm’s 2014 oil forecast by saying, “We're not big bulls. Our analysts forecast $90 a barrel for West Texas Intermediate at year end.”
I’m not purposely singling out the Barron’s roundtable participants; they are smart people and I always look forward to the edited transcripts of their semiannual conversations. But the fact that none of the roundtable participants called for a big drop in oil prices last year—and even went in the opposite direction by recommending oil stocks—shows how difficult it is to predict what will happen in the future. As Gabelli pointed out during the latest roundtable discussion (published in this week’s issue of Barron’s), “A year ago, nobody thought about oil, or Putin invading Crimea, or the spread of Ebola.”
It’s not just oil. Yields on the benchmark 10-year Treasury note have been making significant moves as well. After falling to 1.63% on May 2, 2013, yields spiked to 2.90% over a period of less than four months (May 2 to August 22, 2013) before ending 2013 at 3.03%. Last year (2014), yields reversed course and fell, leading to today's close of 1.90%. It likely would not take much effort to find forecasts predicting yields would be higher now than they actually are.
Then there is monetary policy. Last week, I attended a presentation by St. Louis Federal Reserve president James Bullard. He discussed how the Federal Open Market Committee (FOMC) has been pulled in different directions by better-than-forecast employment and weaker-than-forecast inflation. He added that below-target inflation and the possibility of lower inflation in the future is weighing on the committee’s decision process. If the people responsible for setting monetary policy are unsure about when to start raising rates, ask yourself how much you want to rely on someone else’s forecast about when rates will start to be raised.
There are people who get forecasts right. On Wall Street, people make careers out of getting one or two big forecasts correct. That doesn’t mean they possess soothsaying abilities; rather, it means that they simply got lucky. The role of luck is vastly underestimated. It can make a good strategy seem bad, and a bad call seem brilliant. It also means you should never forget the advice James Montier of GMO once gave: “If you don’t know what is going to happen, don’t structure your portfolio as though you do!”
I fully understand the desire for certainty. It’s a human trait. But Mr. Market doesn’t reward certainty; he rewards you for taking risks. When you take risks, there will be costly market moves. There will also be profitable moves. Which brings me back to reiterating something I’ve said before and will say again in the future: Go with the historical odds about what has worked over the long term and don’t worry about what might happen tomorrow, next week, next month or next year. The only forecast we can make with any accuracy is that something we weren’t anticipating to happen will happen.
The Week Ahead
Nearly 150 members of the S&P 500 will report earnings next week. Included in this group will be Dow Jones industrial average components Microsoft Corp. (MSFT) on Monday; 3M Co. (MMM), AT&T (T), Caterpillar (CAT), Du Pont (DD), Pfizer (PFE), Procter & Gamble Co. (PG) and United Technologies Corp. (UTX) on Tuesday; Boeing Co. (BA) on Wednesday; Visa (V) on Thursday and Chevron Corp. (CVX) on Friday.
The Federal Open Market Committee will hold a two-day meeting starting on Tuesday. Also on Tuesday, December durable goods orders, the November S&P Case-Shiller home price index, December new home sales and the Conference Board’s January consumer confidence survey will be released. Thursday will feature the National Association of Realtors’ December pending home sales index. The first estimate of fourth-quarter GDP, the University of Michigan’s final January consumer sentiment survey and the January Chicago PMI will be released on Friday.
The Treasury Department will auction $26 billion of traditional two-year notes and $15 billion of two-year floating rate notes on Tuesday, $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.
About The Author - Charles Rotblut, CFA is  the VP and Editor for American Association of Individual Investors (AAII).  Charles is also the author of Better Good than Lucky.  (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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