paris 2012 02 09 handout
TRANSCRIPT
Predicting the future: you know more than you think
Prof. Dr. Klaus W. Wellershoff
February, 2012
• Lesson I: We know little about the future!
• Lesson II: What we know is very powerful!
• Lesson III: We spend a lot of time and effort to forget what we know!
2
Lessons learned…
... from 12 years as chief economist of a large bank:
• Low interest rates imply:
• lower returns on all asset classes
• asymmetric expected returns
• changed correlation patterns.
• Forecast errors exist and the investment process needs to reflect this.
3
Things we know as money managers, …
... but rarely reflect on:
A low interest rate world
Impact of low interest rates on expected risk/return trade off
Money Market
Govt. Bonds
Corp. Bonds
Real Estate
Equities
Commodities
Private Equity
Expe
cted
Ret
urn
Systematic Risk
Traditional view
Consensus today
Wellershoff & Partners view
4
Source: Wellershoff & Partners
Source: Thomson Datastream, Wellershoff & Partners
Forecast Accuracy
Equity return forecast errors
0
10
20
30
Annualis
iert
er
Pro
gnosefe
hle
r (R
MS
E)
1 Monat 1 Quartal 1 Jahr 3 Jahre 5 Jahre 10 Jahre
5
Source: Goyal und Welch (2008), Wellershoff & Partners
1 Month 1 Quarter 1 Year 3 Years 5 Years 10 Years
An
nu
alis
ed R
oo
t M
ean
Sq
uar
e Fo
reca
st E
rro
r
Traditional portfolio construction
Standard optimization procedure
6
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0.5% 1.1% 2.0% 3.0% 4.0% 5.0% 6.5% 8.4% 10.7% 14.9%
Por
tfolio
com
posi
tion
Systematic Risk
Po
rtfo
lio C
om
po
siti
on
, S
har
e o
f A
sset
Cla
sses
Source: Wellershoff & Partners
Modern portfolio construction
Robust portfolio optimisation that reflects forecast errors
7
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
0.5% 1.7% 3.3% 5.0% 6.9% 8.9% 11.2% 13.9% 16.9% 20.7%
Por
tfolio
com
posi
tion
Systematic Risk
Po
rtfo
lio C
om
po
siti
on
, S
har
e o
f A
sset
Cla
sses
Source: Wellershoff & Partners
• ... trend growth in this decade will be significantly lower than in the last.
8
Ecoonomic Certainties
We know that...
Future trend growth: World
Optimistic scenario
Growth contribution of population growth
-3
-2
-1
0
1
2
3
Per
cen
tag
e p
oin
ts
1950 1970 1990 2010 2030
USA Japan Germany
China India Switzerland
Investment-to-GDP ratio
0
10
20
30
40
50
60
Per
cen
t
1950 1970 1990 2010 2030
Growth contribution of factor productivity
-2
0
2
4
6
8
10
Per
cen
tag
e p
oin
ts
1950 1970 1990 2010 2030
Trend growth
0
2
4
6
8
10
12
Per
cen
t
2000–09 2010–19 2020–29 2030–39
Source: Penn World Tables, Wellershoff & Partners
Probability of recession
Major economies: 2010 - 2019
0
10
20
30
40
Rec
essi
on p
roba
bilit
y pe
r yea
r
UK US Germany Switzerland Japan
1990s
2010s
10
Source: Penn World Tables, Wellershoff & Partners
• ... trend growth in this decade will be significantly lower than in the last.
• ... government revenue and spending eventually will have to be the same.
11
Economic Certainties
We know that...
Fiscal policy
Deficit in percent of GDP in 2011
10
5
0
5
10
15
Budg
et d
efic
it as
% o
f GD
P
United
States
Irelan
dJa
pan
United
Kingdo
mGree
ce
New Zea
land
France
Portug
alSpa
in
Sloven
ia
Slovak
Repub
lic
Poland
Canad
a
Hunga
ry
Austria
Denmark
Euro ar
eaTurk
eyIsr
ael
Belgium
Czech
Repub
licItaly
Netherl
ands
Estonia
Austra
lia
Icelan
d
German
y
Finland
Luxe
mbourg
Switzerla
ndKore
a
Sweden
Norway
12
Source: OECD, Wellershoff & Partners
Fiscal policy
Change in deficit/GDP-ratio since 2009
0
5
10
15
20
25
Perc
enta
ge p
oint
s ch
ange
in d
efic
it/G
DP
ratio
200
912
Irelan
d
Greece
Spain
Portug
al
Slovak
Repub
lic UK
Netherl
ands
Belgium
France Ita
ly
Finland
Sloven
ia
German
y
Austria
Luxe
mburg
Japa
n
Estonia US
13
Source: OECD, Wellershoff & Partners
Fiscal policy
Stability of debt/GDP-ratios
3
0
3
6
9
12
Perc
ent o
f GD
P
Switzerland Eurozone UK Japan US
Budget Deficit
Nominal GDP Growth
14
Source: OECD, Wellershoff & Partners
• ... trend growth in this decade will be significantly lower than in the last.
• ... government revenue and spending eventually will have to be the same.
• ... there is simply too much debt around.
15
Economic Certainties
We know that...
Real interest rates
Ex ante real interest rates from inflation protected bonds
Source: Thomson Reuters Datastream, Wellershoff & Partners
0
1
2
3
4
5
6
7
8
10Ja
hres
zins
en U
SA in
%
01/02 01/04 01/06 01/08 01/10 01/12date
Nominalzins
Realzins
Inflationserwartung
• ... trend growth in this decade will be significantly lower than in the last.
• ... government revenue and spending eventually will have to be the same.
• ... there is simply too much debt around.
• ... inflation forecasting does not work.
17
Economic Certainties
We know that...
Uncertainties
Forecast errors for CPI inflation over different time horizons
0.0
0.5
1.0
1.5
2.0
2.5
RM
SE o
f for
ecas
t erro
r
3 Months 6 Months 12 Months 18 Months 24 Months
US
Switzerland
18
Source: Wellershoff & Partners
• ... trend growth in this decade will be significantly lower than in the last.
• ... government revenue and spending will have to be the same eventually .
• ... there is simply too much debt around.
• ... inflation forecast models don‘t work at the moment.
• ... GDP forecasts don‘t work at all, but leading indicators do.
19
Economic Certainties
We know that...
Uncertainties
Forecast errors for real GDP growth over different time horizons
0.0
0.5
1.0
1.5
2.0
Roo
t mea
n sq
uare
erro
r of f
orec
ast
Current 6 Months 12 Months 18 Months 24 Months TrendTime horizon of forecast
German Institutes 1998 2008
US Institutes 1990 2004
20
Source: Jochum (2009) & Patton and Timmerman (2010), Wellershoff & Partners
Source: Thomson Datastream, Wellershoff & Partners
Investment Climate
Leading W&P-Indicator
0
10
20
30
40
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Today3 months ago6 months ago
USA
0
10
20
30
40
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Eurozone
0
10
20
30
40
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Germany
0
10
20
30
40
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Switzerland
0
10
20
30
40
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Japan
0
10
20
30
40N
umbe
r of m
onth
s
3 2 1 Mean 1 2 3
China
21
Source: Thomson Datastream, Wellershoff & Partners
Consumption Climate
Leading W&P-Indicator
0
10
20
30
40
50
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Today3 months ago6 months ago
USA
0
10
20
30
40
50
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Eurozone
0
10
20
30
40
50
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Germany
0
10
20
30
40
50
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Switzerland
0
10
20
30
40
50
Num
ber o
f mon
ths
3 2 1 Mean 1 2 3
Japan
0
10
20
30
40
50N
umbe
r of m
onth
s
3 2 1 Mean 1 2 3
China
• ... trend growth in this decade will be significantly lower than in the last.
• ... government revenue and spending will have to be the same eventually .
• ... there is simply too much debt around.
• ... inflation forecast models don‘t work at the moment.
• ... GDP forecasts don‘t work at all, but leading indicators do.
• ... purchasing power parity works in the long run.
23
Economic Certainties
We know that...
Purchasing power parity (PPP) in the long-run
Producer prices in USD
24
Source Taylor & Taylor (2004)
Source: Thomson Datastream, Wellershoff & Partners
Currencies: EURGBP
Actual and purchasing power parity (PPP)
.6
.7
.8
.9
1
1985 1990 1995 2000 2005 2010
EURGBPEURGBP PPPNeutraler Bereich
25
Source: Thomson Datastream, Wellershoff & Partners
Currencies: EURUSD
Actual and purchasing power parity (PPP)
0.60
1.00
1.40
1.80
2.20
1985 1990 1995 2000 2005 2010
EURUSDEURUSD PPPNeutraler Bereich
26
Source: Thomson Datastream, Wellershoff & Partners
Currencies: EURJPY
Actual and purchasing power parity (PPP)
50
100
150
200
250
1985 1990 1995 2000 2005 2010
EURJPYEURJPY PPPNeutraler Bereich
27
Source: Thomson Datastream, Wellershoff & Partners
Currencies: EURCHF
Actual and purchasing power parity (PPP)
1.2
1.4
1.6
1.8
2
1985 1990 1995 2000 2005 2010
EURCHFEURCHF PPPNeutraler Bereich
28
• Expect to see
• weak trend growth
• the end of the trend of falling interest rates
• more fiscal problems – debt crisis and/or fiscally induced slow-downs
• Change your asset allocation
• in all likelihood your strategy is wrong!
• Remember the Alien Song!
29
Simple Conclusions
This report has been prepared and published by Wellershoff & Partners Ltd. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis. Although all information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, no representation or warranty, express or implied, is made as to its accuracy or completeness. All information and opinions indicated are subject to change without notice. Some investments may not be readily realizable if the market in certain securities is illiquid and therefore valuing such investments and identifying the risks associated therewith may be difficult or even impossible. Trading and owning futures, options, and all other derivatives is very risky and therefore requires an extremely high level of risk tolerance. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in foreign exchange rates may have an adverse effect on the price, value or income of an investment. We are of necessity unable to take into account the particular investment objectives, financial situation and needs of our individual clients and we recommend that you take financial and/or tax advice as to the implications (including tax liabilities) of investing in any of the products mentioned herein. This document may not be reproduced or circulated without the prior authorization of Wellershoff & Partners Ltd. Wellershoff & Partners Ltd. expressly prohibits the distribution and transfer of this document to third parties for any reason. Wellershoff & Partners Ltd. will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law.
30
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