2015 anti-forecast – Let valuation not prediction be your guide over the coming year


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

The start of a new year is traditionally seen as the time for all fund managers to opine on the future of economies, markets and the general state of the universe but, ever the contrarians, here on The Value Perspective we are disinclined to join in. Still, rather than have you staring at a blank screen, here are a few thoughts around 2015 in the shape of our annual ‘anti-forecast’.

Sceptical as we may be about the ability of anyone, ourselves included, to predict the future with any accuracy, we would acknowledge that, in the final analysis, economists are rarely ever wrong. This is because, from the moment an economist makes a forecast, they will continually tweak it up and down so that, by the time the official number is released, they have got it ‘right’.

While such a process may serve to help economists feel good about themselves though, it is of little practical use to investors, who are obviously after some sort of reliable forecast months rather than hours in advance. Unfortunately that prospect seems set to remain firmly in the realms of dreamland – and it is not just The Value Perspective that thinks so.

To assess the accuracy of economists’ predictions, the Federal Reserve Bank of Cleveland analysed the Livingston Survey, a comprehensive data series that records forecasts dating back to 1983. Damningly, the research concluded people would be better off relying on so-called ‘naive’ forecasts – basically ones that say things will stay as they are – than on any of the experts covered by the survey.

This is not to say individual economists never did better than the naive forecast – only that none could do so on a consistent basis. Furthermore, whenever an economist did beat the naive forecast, they were unable to repeat the trick the following year – which of course their job rather requires them to do – and indeed they tended to do worse than one might expect from, say, picking a number at random.

So there you have just one more reason why we prefer not to make economic predictions nor to rely on the economic predictions of others. Instead, we look to valuation to be our guide, which is why – in contrast to some other investment commentaries you may have seen – we are relatively cautious on the outlook for the US.

Yes, its economy appears to be doing well – jobs are being created and the falling oil price should benefit US consumers far more than their UK or European counterparts. However, as investors, it is the stockmarket we care about and it already looks to be reflecting a lot of that good news. Certainly US valuations are high relative to history, which in turn points to returns from this point being low.

In the UK, valuations look more reasonable – although we would not want to overstate the prospects for investors. History would suggest that, from today’s level of valuations, one might expect a real return of 3.5% to 4% a year over the medium term – say, three, five or even 10 years. Europe looks to be a similar story although of course some areas are better value than others.

Despite their contrasting economic environments therefore, we would currently be more inclined to hunt for investment opportunities in the relative lowlands of the UK and Europe than the heady heights of the US. Having said that, we would swiftly add that although valuation has proved a reasonable guide for investors over the medium term, it is no short-term indicator.

Here on The Value Perspective, we may feel reasonably optimistic about the prospects for the UK and Europe over a meaningful time period of three years or more but we are keenly aware that, over the next 12 months, markets could go up a lot or a little, or they could down a lot or a little. History – much like economic forecasters – is not a reliable guide as to which is more likely.


Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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