LONDON -- One saying often attributed to Nobel Prize-winning Danish physicist Neil Bohr is, "Prediction is very difficult, especially about the future."
Although this quote has also been attributed to wisecracking baseball coach Yogi Berra and several other satirists, it seems fitting from the mouth of one of the fathers of quantum mechanics.
The perils of prediction
Of course, the big problem with prediction is that the future is both uncertain and unknowable. As a result, many leading economists and investment pundits get crucified by their worst predictions.
For example, who remembers Dow 40,000 by David Elias, who expected the Dow Jones Industrial Average to leap to 40,000 by the year 2016? With the Dow currently standing at around 13,000, it would have to more than triple over the next four years for Elias to be hailed as a visionary.
Likewise, few investors are fooled by investment banks' FTSE 100 (INDEX: ^FTSE) forecasts for the year ahead. From experience, it seems that most analysts simply take one year's final close for the Footsie, add 10%, and then round up to the nearest 100 for the next year's outcome.
OBR = Our Bold Remark
Despite this well-established trend for forecasters to come a cropper, economists, stock-market commentators, and investment analysts keep on guesstimating the future.
Indeed, following the May 2010 general election, the coalition government created the Office for Budget Responsibility, an independent forecasting unit tasked with making official predictions about the U.K.'s public finances.
As it happens, I was trawling through the OBR's latest fiscal forecasts last Friday, looking for data on taxes and spending, when I came across an interesting table.
Forecasting the FTSE All-Share index
It's important for the OBR to predict where the U.K. stock market will go, as share prices govern how much investors pay in capital gains tax, inheritance tax, and stamp duty each year. Thus, the OBR predicts that equity prices will rise from their present level "in line with nominal GDP."
In short, the OBR expects the FTSE All-Share index to rise in line with economic growth, plus inflation. Hence, it forecasts strong growth in share prices in 2012-2013 (7.6%), followed by rises of between 4.8% and 5.7% for another four years.
Overall, the OBR expects the FTSE All-Share to rise by a third over the coming five years, which equates to compound growth of 5.8% a year. Add in an expected dividend yield of, say, 3.8% a year, and you're looking at a forecast return of 9.6% a year for five years.
While this near-10% yearly return from shares sounds attractive, the OBR's predictions are pretty silly.
As we know, history shows that share prices do not go up steadily in nice, straight lines. Instead, they zigzag about, sometimes making huge spikes up and down. For example, the path of the stock market in the 2000s traced a giant 'W' as prices crashed, soared, and crashed again before bouncing back in the spring of 2009.
Therefore, I would take the OBR's forecasts concerning the stock market with a huge pinch of salt. They are massively more likely to be wrong than right, plus they look suspiciously optimistic to me, given the ongoing crisis in the eurozone. Indeed, I suspect that they are the product of political optimism, rather than any genuine belief in a sustained recovery in equity markets.
Finally, I would caution investors to be wary of all "official" predictions, as state-run organizations have incredibly poor prediction records.
For example, in December 2003, the Bank of England changed its inflation target to 2% or less, as measured by the Consumer Prices Index. Since then, the Bank has missed this target 67 out of 99 times, so its success rate is a mere 32%. In other words, the Bank has been wrong on inflation twice as often as it has been right.
Like Professor Bohr -- one of the greatest geniuses of the 20th century -- said, prediction is very difficult. Thus, the OBR's optimism on share prices could well turn out to be more of a sell signal than a cry to buy!
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At the time thisarticle was published Cliff's family portfolio includes FTSE All-Share trackers. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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