Of mice and men

Road to ruin is paved with market prophecies

The long-range forecast factory is in overdrive as the year draws to an end. For financial markets, it may all be an unfortunate, if obligatory, waste of time. In most cases, the 2016 outlook hinges on two unknowables.

First, oil prices. Whether they rise or fall will shape global monetary policy and therefore what happens to bond, stock and currency markets. A drop further below $40 a barrel would mean more defaults on high-yield debt issued by energy firms and more chance of energy wealth funds being net sellers, not buyers, of assets.

But, market forecasters have no idea what will happen to oil prices. The need to balance budgets might eventually spur Opec members to curtail oversupply to boost oil prices. But they could just as easily stick with their current strategy of piling pressure on high-cost producers, such as US shale producers.

Second, there's China. Domestic stock market turmoil earlier this year shook investors' faith that the state could achieve the outcomes it wanted in this huge and opaque economy. Any sharp slowdown would compound weakness in global commodities and the misery of those who produce them, such as BHP Billiton and Glencore.

Nor is it clear how the Chinese currency will behave. Market forecasts will be ripped up if the yuan depreciates markedly. This would roil stock markets and put Asian countries, such as South Korea and Japan, at a competitive disadvantage. And, if they in turn weaken their currencies, there will be yet more global disinflation.

Yet, even if all goes to plan, forecasts can be wrong. Take Goldman Sachs' top 10 market themes for 2015, issued just over a year ago. The thinking underpinning the predictions proved broadly right: US and euro zone policy divergence, downside risks for oil prices, few price pressures. Yet, several market calls were wrong, such as one that US 10-year bond yields would climb to three per cent by year-end.

No one is perfect. And as the surge in German yields in the second quarter or the euro on December 3 showed, price trends are prone to violent upsets when too many investors jump on the bandwagon. Over horizons of a few weeks, market prophecies often prove useful. Long-range forecasting, though, requires a healthy appetite for humble pie.o