January 7, 2004

At this time of year, I traditionally review my outlook from the previous year to determine how well I understood economic conditions and to see if I can learn something from my forecast errors.  Under normal circumstances, my forecast performance was worthy of a high B. 

But there was nothing normal at the beginning of last year.  Venezuela oil production had collapsed from strikes that were to go on for another two months.  North Korea was threatening to use nuclear power to force the U.S. to the bargaining table.  And we were turning up the heat on Saddam Hussein in Iraq. 

Under such circumstances, I believe it is only fair to give me a low A for my forecasting efforts. 

In doing this analysis, I am using comments from my mid-January outlook column as well as the monthly forecasts I post on a brokerage website. 

At the beginning of the year, I was confronting the reality of lost momentum in economic growth, a backslide in employment (we lost another 800,000 jobs before new hiring finally returned in late summer), and further uncertainty in tax policy. 

I expected jobs and corporate spending to begin growing by summer, and they did.  While I expected economic growth to be sluggish in the first half of the year, about 2 percent, I saw growth reaching 4 percent before year end. 

I knew that Federal Reserve activity and tax policy were unusually stimulative.  For this recovery to collapse with so much policy thrust would almost deny my understanding of macroeconomics.  Indeed, my forecast was lower than what I thought that thrust could produce.  My failure to fully accept my economic understanding was the greatest failure of my forecast. 

In fact, the 2 percent first half growth was only slightly too conservative.  Of course, we zoomed past 4 percent in the summer and should stay above 4 percent this fall. 

Because of Venezuela's oil problems, I saw inflation surging in the winter but then subsiding during the summer to less than 2 percent.  In fact, prices did surge and then fall.  In November, consumer prices were only 1.8 percent above previous year levels. 

I suggested that the Federal Reserve might even "lower rates" in the winter.  They did so in the spring and then held 1 percent for federal funds rates for the remainder of  the year. 

I expected ten year government bonds to yield about 4 percent all year.  In fact, deflationary concerns pushed rates down to nearly 3 percent in June.  By the end of the year, however, yields are slightly over 4.1 percent. 

I think I should be excused for not seeing the deflationary flash before reasoned thinking restored more appropriate yields to long term rates.  I mentioned that mortgages would continue to fall, which certainly occurred until summer. 

I took a lot of criticism for suggesting that the stock market already was in a rising channel as the year began.  In fact, the October lows were tested but held in March, and then the bull market surged in earnest.  By the end of the year I was looking for a "sustained rally to challenge 10,000.late in the fall." 

As far as stock market forecasting is concerned, that is a direct hit.  I hope my readers saw as much improvement in their investments as I did this past year. 

Wages grew less than I expected, but my use of the word "anemic" for wage increases captured reality.

Unemployment only reached 6.3 percent before subsiding (I expected 6.5 percent), but I again captured the essence of labor market conditions. 

Consumers spent more robustly than I expected and the savings rate was lower.  I worried about auto markets being satiated.  That worry materialized in the fall, but not as dramatically as I thought. 

While I certainly did not paint a perfect picture of the 2003 economy, I certainly had all the correct outlines, and some of the detail was remarkably close. 

So what did I learn?  First, even if corporations tell you they do not see improvement, use your training and trust economic theory.  Theory certainly did not fail me this time. 

Second, unless "geopolitical" issues directly impact economic conditions such as oil supplies or trade deficits, their impact upon the economy is fleeting.  Economic behavior is more robust than most people want to believe.  

And I still am a pretty good forecaster.  So let me enjoy my low A, even if there were a few rough spots when you look more closely at the 2003 forecasting portrait. 


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