Little inconsistencies do not seem to bother forecasters. They are never wrong, they just change their mind

It is often traditional for commentators at the end of the year to make predictions about the coming year. Since I was not born with the gift of prophecy and cannot see the future, I have decided to do the next best thing. Rather than make predictions myself, I'm going to examine other predictions.

No analysis would be complete without a review of predictions from the most influential analysts and economists at international banks. These banks, including Goldman Sachs, Credit Suisse, UBS and Morgan Stanley, Bank of America, JPMorgan Chase, Citigroup and Deutsche Bank among others, employ vast armies of experts trained to read the entrails of the global economy and predict the future.

It is not surprising that many other predictions are heavily influenced by the present. For example, 2010 has been an excellent year for commodities and emerging markets. Goldman Sachs feels that these trends will no doubt continue. Last year a weak US economy moderated global demand. "This is likely to change in 2011 with a stronger US that is likely to bump up against a China that is consuming dramatically more commodities than pre-crisis." Logically they predict that "the raw materials most affected will be those with the tightest supply, including crude oil, copper, cotton, soybeans and platinum." Of course, gold is included in this prediction. It is supposed to rise to a new high of $1,690.

One major element of this prediction is that China will continue to grow and its demand for commodities will continue. In the past, this has been a relatively safe prediction, but it may not be true this time. For example, Morgan Stanley predicted that Chinese inflation would be moderate in 2010. Instead it has grown rapidly. From 3% it is now above 5%. The voracious demand for commodities from China in 2010 has increased their price which has increased Chinese inflation.

To deal with that inflation will require substantial tightening and slowing of the Chinese economy. The Shanghai Composite Index has been expecting this Sword of Damocles to fall for most of the second half of 2010. As a result, despite the predictions, it has performed poorly. It is down over 10% in 2010 in contrast to US markets, which are up about 10%. This is a dramatic contrast to an 80% spike for the Chinese market in 2009.

The expectations of the Chinese markets were satisfied by the Christmas Day hike in interest rates. While the interest rates themselves may not yet have the effect on the Chinese economy that one would expect in a Western market, it does send a powerful signal.

Getting China wrong is not that uncommon. Goldman Sachs predicted that the Chinese economy would grow by only 6% in 2009. In fact it grew over 9.3%. One of the reasons for inaccurate predictions has to do with the expert's cognitive bias of anchoring. They have a stake in seeing their past predictions come true. As a result they may not want to consider information that contradicts their forecast.

The changes are evident to Yu Yongding, former head of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences and Chinese central bank's monetary policy committee, who wrote that "[China's] growth pattern has now almost exhausted its potential. So China has reached a crucial juncture: without painful structural adjustments the momentum of its economic growth could suddenly be lost."

For the US market, forecasters are predicting "a low US real interest-rate environment will continue in 2011, particularly given the resumption of quantitative easing measures in the US."  The problem with this forecast is that quantitative easing has not resulted in low real interest rates in the US. When first announced, interest rates for 10-year US treasury bills were below 2.5%. Now they are above 3.5%.

Little inconsistencies do not seem to bother forecasters. They are never wrong, they just change their mind. In October 2010, Goldman Sachs predicted that the US economy would slow to 1.8% from 2.6%. By December, they had a change of heart. The forecast has increased almost 40% and they now predict that the US will grow at 2.5% through early 2011 and then almost double to a 4% annual growth rate.

The reality is that the predictions by these experts are basically worthless. Professor Philip Tetlock from the University of California did a study of 82,361 forecasts by 284 people who made their living making forecasts. What he found was that "Human beings who spend their lives studying the state of the world, in other words, are poorer forecasters than dart-throwing monkeys."

So why bother with predictions at all? Investors do not need to know whether the prediction is right or wrong. To profit, it is important to understand the extent a prediction influences the market, so they can profit when the truth finally becomes known.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected] or [email protected])