economic forecast

And Now, the Weather

© Can Stock Photo / ifeelstock

When you watch the news and the weather forecaster tells you there is an 80% chance of rain tomorrow, what exactly does that mean?

It might rain tomorrow, or it might not. It says rain is more likely than not. So if there is no rain after all, does that mean that the forecast was wrong?

Forecasting is often a fuzzy subject. No one can see the future with 100% certainty, so predictions are often spoken of in terms of probabilities. But we as humans are generally not good at thinking in terms of probability. An 80% chance is far from a sure thing, but when someone tells us something is 80% likely to happen, it can sometimes feel like one.

This is particularly true when it comes to trying to predict one-time events. If you flip a coin and it comes up tails, you can keep flipping it and see that it will still come up heads about half the time. If the weather forecast says there is an 80% chance of rain next Tuesday, there is only one next Tuesday. If Tuesday comes and goes without any rain, it sure feels like the forecaster blew it.

Economic and financial forecasting runs into the same problem. First, a forecast is only as good as its model. Economic projections may include assumptions that prove to be unfounded. But even a good forecast is limited to predicting a range of probabilities. If an analyst tells you they think there is an 80% chance that the market will go up this quarter, all they are really saying is that it might go up and it might go down. You probably did not need an analyst with a fancy model to tell you that.

We put little faith in short term market predictions. Even if they are accurate, you can probably not afford to bet the farm on them. We prefer to take a longer-term view. We cannot be sure how an investment will perform over the next month or next year, and do not believe in speculating on short term results. We feel much more comfortable in the trend over the long run.

Clients, if you have any thoughts or questions, please call or email us.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Cars and Trucks, Philosophy and Money: A Research Case Study

© www.canstockphoto.com / Apriori

How do YOU get where you want to go? Transportation. We are invested rather fully in automakers and related companies, so we pay a lot of attention to this vital sector of the economy.

Many companies in the sector are reaping handsome revenues and profits, paying generous dividends, and yet the valuations in the marketplace do not reflect the good results. Some say this is because vehicle sales are at a peak, 17 million units a year, so stock prices reflect a future decline in revenues and profits. Others forecast new sales records ahead for the industry, with rosier outlooks. Who is right?

With 260 million light vehicles in the US fleet, it seemed to us that 17 million, or one-fifteenth of the fleet, was clearly a sustainable annual sales pace. After all, replacing 1/15th of the fleet does not seem excessive.

But we know the story is a little more complicated than that. We wanted to see how annual sales compared to fleet size through recent history. We looked back at annual sales data from Wards Auto and annual fleet size from the U.S. Bureau of Transportation. It turns out that the current rate of about 6% annual-sales-to-fleet ratio is in the middle of the 4 to 8% range that has prevailed over the last 25 years.

Annual sales are made up of two things: changes to the size of the fleet, and replacement for existing vehicles in the fleet. Annual sales equal the change in the fleet plus a replacement factor of 5.5% of the fleet, on average, over the past twenty five years. This means that we are replacing 1/18th of the fleet every year.

We immediately wondered if replacing 1/18th of the fleet makes sense—eighteen years is a long time to replace the whole fleet! But if that replacement rate held steady for many years, the average age of the fleet would not be eighteen years, but only half that—nine years. With the current actual average age at eleven years (Ward’s data), this makes sense.

What does it all mean? When you figure a replacement rate of 5.5% plus a fleet growth rate equal to population growth, or use the average fleet growth rate of 1.2% over the last twenty-five years, you find that annual average sales might be in the 16.5 million to 17.5 million range going forward.

The upshot is that the current sales rate may be near the actual equilibrium pace, with future years coming in higher or lower depending on economic and other factors. We reject the notion that current sales are at an unsustainable peak, while acknowledging they will go up and down.

We know the future rarely follows a straight line from the present, though. Think of the dramatic evolution that the automobile has undergone in our lifetimes: fuel injection, catalytic converters, four wheel drive, air bags, onboard computers… what’s next? The work of understanding the world is never done, and we will always be researching and studying to further our knowledge.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.