Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

Wednesday, 30 January 2013

The problem with forecasting

Lay security analysis

Ben Graham once said this of valuing securities:

“In 44 years of Wall Street experience and study, I have never seen dependable calculations made about common stock values - or related investment policies - that go beyond simple arithmetic or the most basic algebra.

Whenever calculus is brought in or higher algebra, you could take it is as a signal that the operator was trying to substitute theory for experience, and also to give speculation the deceptive guise of investment.”

Very important quote that.

What Graham is saying that when making forecasts of the future, any prediction which goes beyond a very broad brush approach involves so many unknowns about the future that there is little value in trying to forecast with any level of accuracy.

The most dependable branch of security analysis, therefore, is that of rating bonds, because analysts can use interest cover ratios – a known current figure – in order to rank them.

When it comes to valuing stocks there is a great difficulty in projecting an unknown growth rate on earnings into the future.

The further into the future one tries to project, the more sensitive the calculation becomes to slightest error.

Forecasting in action

The cited example is that if you ascribed a 15% growth rate to a company’s earnings today of $1, in 15 years the earnings would climb to $8.14 – a growth rate and earnings power which might justify a valuation of 35 times earnings at £285.

But if the projected earnings growth rate was only to be 14% then the earnings would only climb to $7.14 over the same period. Investors might only be inclined to value such a growth rate and earnings power at 20 times earnings, and thus the final stock valuation would come in at only $140 – a drop of some 50% from the first example.

This example is fairly involved, but the principal is absolutely correct: as the future contains so many unknowns, forecasts become highly sensitive to small errors.

Black Swans

Nassim Nicholas Taleb would take this a step further and suggest that Black Swan events affect forecasts in such dramatic and unforeseen ways that all forecasts of the future are effectively rendered useless.

The problem with Taleb’s point is that by definition humans can do very little about such unknowns until they become known, and therefore the forecasting models of standard deviations and bell curves have no suitable replacement.

We can only make forecasts based upon what we do know, not upon what we do not.

Three decades ago, no-one forecast the internet, after all!


I’ve recently been reading Debunking Economics by Steve Keen. It’s a good read and includes some thought-provoking ideas. Think back to Graham’s quote:

Whenever calculus is brought in or higher algebra, you could take it is as a signal that the operator was trying to substitute theory for experience”.

Keen himself said that he was no expert on house prices and indeed that house prices are only a tiny part of his interest, but after he predicted a major collapse in the debt and housing market he was perhaps a little unexpectedly thrust into the headlines.

Keen invokes some phenomenally complex models to show why he believes debt levels will come down.

I don’t pretend to understand all of them and I think it’s an unnecessarily cheap shot when he is met with smart-@rse comments like “tell me what the wires do”. The fact is that Keen comes up with some thought-provoking stuff.

I think, though, that if we are to see a slow or accelerated period of debt deflation, it is as likely to be driven by human emotion as it is by phenomenally complex economic models or second and third derivatives models of credit growth.


In this regard, the Minsky Model has something to be said for it: it talks of investors becoming spooked and fleeing the market due to the income not covering the debt repayments.

It’s a valid enough theory although in Australia we do have tax laws and sometimes government incentives which distort the market.

The credit markets and the availability of cheap money or otherwise play a key role in debt levels. So does affordability – the natural speed limit on property prices is people’s ability to pay for it.

But also so does rational profiteering and the invisible hand of capitalism. Investors buy property to make money, no other reason. And homebuyers and first homebuyers buy purely out of self-interest too. If they believe prices will fall, they tend not to buy.

Stock prices and house prices and driven much by human emotions. If people believe they will be higher in the future, they tend to buy, and if they believe they will be lower they tend to sell.

Forecasters, including Shane Oliver of AMP and a number of other highly respected economists, forecast reasonably strong stock price growth and moderate property price growth for 2013 but then as was famously once said:

“The only function of economic forecasting is to make astrology look respectable”.

Aussie stocks completed a tenth consecutive positive trade yesterday as the bull market continues to show its horns.


After a decent break, I’m flying back to East Timor tomorrow.