Economists Were 100% Wrong About the 2010s, So Ignore Them for the 2020s

To better understand 2020 predictions, we should consider context and history. First, what has history told us about economic forecasts? We don’t have to look further than decade forecasts from 2009.

What Economists Said About the 2010s

As 2009 ended, investors and economists were shell shocked. They’d experienced two bear markets in the previous ten years with stock prices losing more than 50% twice. Major stock market averages hadn’t suffered such steep declines since the Great Depression.

The first bear market was the natural response to a bubble everyone saw coming. Something we all now know at the “dot com bubble“. In hindsight, internet stocks were overpriced in 2000.

The cause of that second bear market was less obvious, even in hindsight. What we all now know as the housing crisis. Subprime mortgages and real estate shouldn’t have led to a 50% decline in blue chip stocks.

A recovery seemed to be underway at the end of 2009. At least in the stock market. The S&P 500 was a stunning 67% above its March 2009 lows, in just 9 months.

The economy seemed to be recovering, Unemployment was at 9.9% but was moving down from its peak of 10%. Interest rates were near zero and that would ensure a quick recovery.

Economists were confident that interest rates would start rising in 2010 and be above 4% by 2015 before the next recession forced the Federal Reserve to reduce rates again.[1]

Economists Were Wrong

Over the next ten years, the Fed funds rate, an important short-term interest rate, never topped 2.5%. This was a level that seemed impossibly low prior to 2000. In 2009, economists were certain short-term rates would settle between 3% and 5%, in line with their long-term average.

The chart below shows Fed Funds remained below 1% until 2017.

Source: Federal Reserve [2]

Many economists worried about inflation because they believed low rates were a breeding ground for inflationary pressures.  This explained how the Federal Reserve operated for more than 90 years. It simply rates to offset inflation.

Inflation was about 2% in late 2009 and ended the decade near 2% after peaking near 3.8% in 2011. The consumer price index was above 3% for just 10 months in the decade.

Economists long feared inflation would rise because they believed declining unemployment would lead to higher wages and inflation. It was a long-standing theory known as the Phillips Curve.

According to the Fed, the theory was that “years of high unemployment rates tended to coincide with steady or falling wages and years of low unemployment rates were also years of rising wages.” [3]

Unemployment now coexists with low inflation, an unexpected result under standard economic theory.

Source: Federal Reserve [4]

What Lies Ahead?

After failing to forecast the 2010s, economists are questioning their assumptions for the next decade. 2020 predictions are slowly trickling in now. Federal Reserve officials now talk of being “data dependent” and responsive to current conditions. In the past year, officials have cited concerns about trade wars and international developments in their decisions.

This indicates an understanding that theories that worked in the past need to be reevaluated. Policy makers around the world are now experimenting to a degree.

One thing that hasn’t changed is the fact that central bankers have confidence is their abilities to react. They tend to believe they will foresee the next crisis and act in time to prevent it or to at least mitigate the downside.

In 2000 and 2008, and in every crisis since the founding of the Federal Reserve, officials have struggled to react to crises. That seems to be the safest forecast for the 2020s. Expect a crisis. Expect the Fed to miss the crisis and struggle to contain the fallout.

In the 2020s, there will be bear markets and they will be deep. While policy makers cannot react quickly, traders can. When the stock market begins falling, they should react to reduce their losses. This will mean selling rather than holding on for dear life. Selling could be the best thing traders can do in a decline.

Michael Carr, CMT, CFTe

Editor, Peak Velocity Trader

 

Sources:

[1]: The Wall Street Journal – Economists Got the Decade All Wrong. They’re Trying to Figure Out Why.

[2]: Federal Reserve – Effective Federal Funds Rate

[3]: Federal Reserve – Dr. Econ, what is the relevance of the Phillips curve to modern economies?

[4]: Federal Reserve – Unemployment Rate