percentage point) in average annual returns for each week during the
four-month period in which investors can predict the business cycle
turning point.
The extra returns from successfully forecasting the business cycle
are impressive. An increase of 1.8 percent per year in returns, achieved
by predicting the business cycle peaks and troughs only one month be-
fore they occur, will increase your wealth by over 60 percent over any
buy-and-hold strategy over 30 years. If you can predict four months in
advance, the annual increase of 4.8 percent in your returns will more
than triple your wealth over the same time period compared to a buy-
and-hold strategy.
HOW HARD IS IT TO PREDICT THE BUSINESS CYCLE?
Billions of dollars of resources are spent trying to forecast the business
cycle. The previous section showed that it is not surprising that Wall
Street economists desperately try to predict the next recession or upturn
since doing so dramatically increases returns. But the record of predict-
ing exact business cycle turning points is extremely poor.
Stephen McNees, vice president of the Federal Reserve Bank of
Boston, has done extensive research into the accuracy of economic
forecasters’ predictions. He claims that a major factor in forecast accu-
racy is the time period over which the forecast was made. He con-
cludes, “Errors were enormous in the severe 1973–1975 and 1981–1982
recessions, much smaller in the 1980 and 1990 recessions, and gener-
ally quite minimal apart from business cycle turning points.”^8 But it is
precisely these business cycle turning points that turn a forecaster into
a successful market timer.
The 1974 to 1975 recession was particularly tough for economists.
Almost every one of the nearly two dozen of the nation’s top economists
invited to President Ford’s anti-inflation conference in Washington in
September 1974 was unaware that the U.S. economy was in the midst of
its most severe postwar recession to date. McNees, studying the fore-
casts issued by five prominent forecasters in 1974, found that the median
forecast overestimated GNP growth by 6 percentage points and under-
estimated inflation by 4 percentage points. Early recognition of the 1974
recession was so poor that many economists “jumped the gun” on the
216 PART 3 How the Economic Environment Impacts Stocks
(^8) Stephen K. McNees, “How Large Are Economic Forecast Errors?” New England Economic Review,
July/August 1992, p. 33.