Persistent Overoptimism Three Ways: Truckers, Fed Economists, Manufacturers
The other day I noted a persistent overoptimism regarding manufacturers.
Since then, I have seen a couple articles regarding overoptimism at the Fed and overoptimism in trucking. Of course, there is also persistent overoptimism about earnings growth and stock market expectations.
The track record on recessions is perfect. The Fed never sees them coming. Let's investigate the overoptimism phenomena starting with trucking.
Profit-Killing Overcapacity in Trucking Coming Up
SupplyChain247 asks Is the U.S. Trucking Industry Entering a Profit-Killing Era of Overcapacity?
As surface transportation's peak period ends for the year, and trucking eyes the traditionally slowest time for the industry as first quarter 2016, economic signals are, at best, mixed.
U.S. factory activity grew last month at its slowest pace since May 2013 as manufacturers pared their stockpiles and cut jobs.
The Institute for Supply Management's index of factory activity slipped to 50.1 in October from 50.2 in September. The figures barely signal growth, which is any reading above 50.
Third-quarter Gross Domestic Product grew at a 1.5 percent annual rate in the third quarter, far below the 3.9 percent pace in the April-June quarter.
What the Economists Are Saying
"We're hopeful this will mark the low," Ian Shepherdson, an economist at Pantheon Macroeconomics, said in a note to clients. "It looks as though the downshift in manufacturing activity may be coming to an end."
ABF Freight, the seventh-largest LTL carrier reported a decline in revenues due to lower fuel surcharges and lower tonnage levels, even though shipments rose year over year. But ABF showed "great cost discipline," Stifel analyst David Ross noted.
UPS Freight, the fifth-largest LTL, reported tonnage off 10 percent (matching the record decline reported in the 2009 3Q during the depth of the Great Recession) and shipments down 5 percent year over year (the worst drop since 2008 fourth quarter).
That has spread to the truckload side as well. Heartland Express, the 12th-largest TL, reported a whopping 35 percent drop in third quarter earnings year of year. Operating revenue decreased 15.9 percent to $182.5 million. Revenue, excluding fuel surcharge revenue, decreased less precipitously, by 8.1 percent to $160.7 million.
Bob Costello, chief economist for the American Trucking Associations, recently told an industry gathering that the third quarter economic slowdown was merely a blip on the radar, fueled by manufacturers and retailers burning off excess inventory from earlier in the year.
"The U.S. economy is on sound footing," Costello said at the ATA Convention in October. "When the inventory adjustment is done, there will be a high level of freight."
"My personal belief is the trucking industry needs to realize production of goods will have ups and downs," Satish Jindel, principal of SJ Consulting, which closely tracks industry pricing, told Logistics Management. "They should not build capacity built on rosy outlooks coming from economists and other organizations that have a bias to be optimistic.
"The reality should show they should only have capacity to handle base GDP growth rate," JIndel added. "Everything above that should be handled by methods that can provide capacity on interim basis. So they're not stuck with excess drivers and trucks."
So far, the industry does not appear to be doing that. Sales of Class 8 heavy trucks are on pace for one of the best years in history - around 260,000 units in North America. That is a warning sign of future overcapacity, Jindel said.
Bias for Optimism
It's interesting that Jindel noted the bias of optimism. I was just looking at a San Francisco Fed study on Persistent Overoptimism about Economic Growth.
In November 2007, the Federal Open Market Committee began releasing projections for real GDP growth four times per year in its Summary of Economic Projections (SEP). The SEP reports the central tendency and range for real GDP growth forecasts from the Federal Reserve Board members and Federal Reserve Bank presidents. Over the past seven years, many growth forecasts, including the SEP's central tendency midpoint, have been too optimistic. In particular, the SEP midpoint forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently overpredicted the speed of the recovery that started in June 2009. The SEP growth forecasts have typically started high, but then are revised down over time as the incoming data continue to disappoint. Similar patterns are observed in the consensus private-sector growth forecasts compiled by the Blue Chip Economic Survey. This Economic Letter reviews the SEP's track record of forecasting growth and considers some explanations for the optimistic bias.
The SEP growth forecast for 2008 never turned negative. At the time, the mainstream view was that the U.S. economy would avoid a recession despite the ongoing housing market turmoil. The actual growth rate for 2008 turned out to be -2.8%--the largest annual decline since 1946. The SEP growth forecast for 2009 did not turn negative until January 2009. This was the first forecast released after the Lehman Brothers bankruptcy in September 2008. The 2009 growth forecast reached a low point of -1.7% in April 2009 but was later revised up, coinciding with a rebound in stock prices. The actual growth rate for 2009 was -0.24%.
A notable feature of the SEP growth forecasts for 2011 through 2013 are the extremely high starting values--around 4% or higher. The last period of multiyear growth over 4% in the U.S. economy was during the tech-bubble years of 1996-99. The overoptimistic SEP growth forecasts for 2011 through 2013 were eventually cut in half, each ending around 2%. The actual growth rates for those years were 1.7%, 1.6%, and 3.1%.
Explaining the Persistent Overoptimism
In a cross-country study of private-sector forecasts from 1989 to 1998, Loungani (2001) finds that "the record of failure to predict recessions is virtually unblemished." He also finds that forecast revisions in one direction tend to be followed by further revisions in the same direction and that one-year-ahead growth forecasts are typically too optimistic.
An updated study by Ahir and Loungani (2014) finds that the private-sector's record of failure to predict recessions remained intact through 2008 and 2009. A study by Alessi, et al. (2014) finds that one-year-ahead growth forecasts from the Federal Reserve Bank of New York and the European Central Bank from 2008 to 2012 exhibited substantial overoptimism, averaging 1.6 to 2.4 percentage points above actual growth. The SEP growth forecasts fit the pattern of these various studies.
According to the SEP, "each participant's projections are based on his or her assessment of appropriate monetary policy." A possible explanation for the SEP's prediction of a rapid catch-up to potential GDP after 2009 is that participants overestimated the efficacy of monetary policy in the aftermath of a so-called balance-sheet recession. Recessions triggered by financial crises are typically preceded by sustained episodes of bubbly asset prices and debt-financed spending booms. When the bubble bursts, the resulting debt overhang forces borrowers to repair their balance sheets via reduced spending or default. Borrowers have too much debt, so monetary policy actions designed to encourage more borrowing by lowering interest rates are less effective. Balance-sheet recessions are typically followed by sluggish recoveries and permanent output losses, that is, real GDP never returns to its pre-crisis path (Bank for International Settlements 2014). The SEP's overprediction of the speed of the recovery could also be linked to other factors. These include possibly underestimating the damage to the economy's supply side, as evidenced by the downward revisions to potential GDP, or perhaps expecting larger effects from stimulative federal fiscal policy.
A final explanation for the pattern of SEP growth forecasts may be linked to a natural human tendency to assume that recent trends will continue. Research shows that people tend to use simple forecast rules that extrapolate from recent data (Williams 2013). For example, one could forecast four-quarter growth over the coming year using only the most recent observation of quarterly growth in the preceding year. The backward-looking nature of this forecasting rule would help explain the failure to predict recessions.
Implications for Economic Models
Research has identified numerous instances of persistent bias in the track records of professional forecasters. These findings apply not only to forecasts of growth, but also of inflation and unemployment (Coibion and Gorodnichencko 2012). Overall, the evidence raises doubts about the theory of "rational expectations." This theory, which is the dominant paradigm in macroeconomics, assumes that peoples' forecasts exhibit no systematic bias towards optimism or pessimism. Allowing for departures from rational expectations in economic models would be a way to more accurately capture features of real-world behavior (see Gelain et al. 2013).
Undoubtedly, economists are among the most perpetually overoptimistic persons on the planet. But it's not just economists.
I commented on manufacturers' optimism on Wednesday in Tracking Manufacturing's Perpetual Overoptimism.
I took the New York Fed regional data which compares current condition to future expectations six months from now, then shifted the expectations forward by six months.
Here is the result of my mini-study on optimism.
Current Business Conditions vs. Expected Business Conditions (For Now - Made
Six Month Ago)
The perpetual overoptimism is impossible to miss. Here are the readings for 2015.
In 167 months, nearly 14 years of data, there were only five months (just under 3% of the time) in which current conditions exceeded projections made six months previous!
The above pattern should not be hard to spot. Overoptimism only dies at or near recession troughs.
Useless Survey Projections
It's amazing how much focus is on totally useless "expectations".
Rare pessimism seems to mark bottoms, but the rest of the time the look-ahead projections are only good for those in need of a laugh.
By the way, I expect another "Peak" line at the top of the above table sometime reasonably soon. The Fed will be shocked when it happens. It has a perfect track record of missing recessions.