Where will the next shock come from?

ECONOMIC VIEW; Then, of course, just when the markets are convinced all is well, there will be some sort of disaster

Surprises make people money. Or rather they make money for people whose job it is to deal in the financial markets, for once an item of news is "in the market" there is no turn: what matters in the narrow perspective of markets is not whether figures are good or bad in themselves but whether they are better or worse than expected.

There are therefore two games which anyone interested in markets ought to play. One is fun. It is to keep asking themselves where the next potential surprise might come from: a figure, a change of policy, maybe just a change of fashion. The other is (usually) less fun. It is to look back at one's own views and see where one has got things completely wrong. More of the former in a moment, focus first on the latter.

Up to now there has been very little ordered analysis of the performance of economic forecasters. People do rankings of individual forecasts for the UK economy - who got things right and who got them wrong. Expect the results of an interesting little exercise of this nature to be published in this paper on Wednesday. But they do not look at the generality of forecasts and plot where the consensus has been optimistic and where it has been pessimistic. So a new indicator developed by the investment bankers Kleinwort Benson deserves a welcome: the surprise activity indicator.

The idea is very simple. You take the consensus forecasts each month for several indicators of the UK economy and then compare these with what actually happens. You can then see whether forecasters as a whole have been over-optimistic or over-pessimistic about the UK economy. Kleinwort has drawn up a composite indicator based mainly on gross domestic product, retail sales, industrial output, unemployment and money supply, the results of which over the last two years are shown in the surprise activity indicator graph.

You can see that for the whole of 1994 things turned out better than expected: the economy grew faster, inflation was lower, unemployment declined more quickly. If you think back, everyone started the year wondering whether the recovery would be sustained and how long it would be before unemployment stopped rising. We ended up with growth of nearly 4 per cent.

Last year proved the reverse. Everyone thought that the low-inflation boom would continue, whereas growth faltered and the inflation numbers rose. When the Treasury came out with a 3 per cent growth forecast in the November Budget, it was dismissed as unduly rosy.

Now, once again, things are beginning to turn out better than expected: the three-month moving average has just blipped positive. This raises the intriguing possibility that the year as a whole might turn out better than expected, for there does seem to be some sort of "fit" between surprises and out-turn. Indeed, better than that: changes in the surprise indicator seem to be a lead indicator for changes in economic growth.

The period from 1988 onwards is plotted on the other graph. Anyone who is interested in statistics will notice that quite a bit of pushing around of the figures has gone on to make the two series fit as well as they do. It seems that you have to take a 12-month moving average for the surprise indicator rather than a three-month one; you use non-oil GDP, which is fair enough; you have to fiddle with the scales and you have to put the zero on the surprise indicator at just under 2 per cent on the growth side. But once you have done all that, hey presto, there is a nice three or four-month lead indicator of the turn of the recession in 1991 and a slightly less clear indicator of the slowdown in growth that took place last year.

Most interestingly there is a hint now that the growth pause of last year may soon be over. We will have to see whether the surprises continue to be on the positive side, but the much-derided Treasury forecast appears a wee bit more credible now than it did in November. Kleinwort will carry on monitoring this series and I will update people in the next few months if anything interesting emerges.

What about the second game noted above, the "where will the next one come from?" Here there is not much to be done by feeding numbers through computers and trying to spot relationships - you just have round up the potential suspects and nab the ones that appear promising. Kleinwort suggests that higher growth will surprise us on the upside by the middle of the year, but that inflation expectations will rise too on the back of this, which would presumably be bad for gilts.

My own list of candidates would certainly include higher growth this year, but I would be more concerned about the balance of payments than inflation, as British consumers always tend to want to buy imported goods when they become a bit richer. My worries for the bond market would come from political uncertainty rather than current inflation.

But the most interesting surprises, surely, go beyond the range of the Kleinwort Benson exercise, for they will be external ones. In the broad scheme of things the British economy is not very important. What matters are the grand global changes of mood which occur from time to time.

Some examples. A year ago only the brave predicted that EMU might have to be postponed or even abandoned. Now the former is seen as odds-on, while the latter is something close to an even bet. Few people saw the French riots coming, and the consequences of that are still unclear.

There are potential surprises in the energy market (the oil price falling off a cliff?), and more generally in commodities (ditto?). Forecasts for the German and French economies have been revised down so dramatically that I suppose the most surprising thing there would be for a year of adequate growth. That would at least be more surprising than actual recession on the Continent, which at the moment looks all too possible.

Finally, there remains the future of the long, long bull market in US securities. As each month of higher Wall Street prices passes the quietly whispered possibility of a speculative blow-off in US share prices, followed by a crash, becomes more likely: the surge running on and on until the music suddenly stops. Maybe the potential surprise there would be for the bull market to continue intact through 1996 and well into 1997.

But all this goes far beyond the scope of the Kleinwort exercise. The most useful conclusion that flows from that is that if the pattern of the last few years continues, we should expect several more months, perhaps a year, of better performance from the British economy than the markets at present expect.

Then, of course, just at the moment when the markets are convinced that all is well, there will be some disaster.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Admin Assistant

£12000 - £15000 per annum: Recruitment Genius: An expanding Insurance Brokerag...

Ashdown Group: Editor-in-chief - Financial Services - City, London

£60000 - £70000 per annum + benefits : Ashdown Group: A highly successful, glo...

Guru Careers: Pricing Analyst

£30 - 35k (DOE): Guru Careers: We are seeking a Pricing Analyst with experienc...

Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

Day In a Page

Revealed: Why Mohammed Emwazi chose the 'safe option' of fighting for Isis, rather than following his friends to al-Shabaab in Somalia

Why Mohammed Emwazi chose Isis

His friends were betrayed and killed by al-Shabaab
'The solution can never be to impassively watch on while desperate people drown'
An open letter to David Cameron: Building fortress Europe has had deadly results

Open letter to David Cameron

Building the walls of fortress Europe has had deadly results
Tory candidates' tweets not as 'spontaneous' as they seem - you don't say!

You don't say!

Tory candidates' election tweets not as 'spontaneous' as they appear
Mubi: Netflix for people who want to stop just watching trash

So what is Mubi?

Netflix for people who want to stop just watching trash all the time
The impossible job: how to follow Kevin Spacey?

The hardest job in theatre?

How to follow Kevin Spacey
Armenian genocide: To continue to deny the truth of this mass human cruelty is close to a criminal lie

Armenian genocide and the 'good Turks'

To continue to deny the truth of this mass human cruelty is close to a criminal lie
Lou Reed: The truth about the singer's upbringing beyond the biographers' and memoirists' myths

'Lou needed care, but what he got was ECT'

The truth about the singer's upbringing beyond
Migrant boat disaster: This human tragedy has been brewing for four years and EU states can't say they were not warned

This human tragedy has been brewing for years

EU states can't say they were not warned
Women's sportswear: From tackling a marathon to a jog in the park, the right kit can help

Women's sportswear

From tackling a marathon to a jog in the park, the right kit can help
Hillary Clinton's outfits will be as important as her policies in her presidential bid

Clinton's clothes

Like it or not, her outfits will be as important as her policies
NHS struggling to monitor the safety and efficacy of its services outsourced to private providers

Who's monitoring the outsourced NHS services?

A report finds that private firms are not being properly assessed for their quality of care
Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

Zac Goldsmith: 'I'll trigger a by-election over Heathrow'

The Tory MP said he did not want to stand again unless his party's manifesto ruled out a third runway. But he's doing so. Watch this space
How do Greek voters feel about Syriza's backtracking on its anti-austerity pledge?

How do Greeks feel about Syriza?

Five voters from different backgrounds tell us what they expect from Syriza's charismatic leader Alexis Tsipras
From Iraq to Libya and Syria: The wars that come back to haunt us

The wars that come back to haunt us

David Cameron should not escape blame for his role in conflicts that are still raging, argues Patrick Cockburn
Sam Baker and Lauren Laverne: Too busy to surf? Head to The Pool

Too busy to surf? Head to The Pool

A new website is trying to declutter the internet to help busy women. Holly Williams meets the founders