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Three tie for first place in economic forecasting

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Inflation kicked up in the past year. The economy grew at a decent clip. Oil prices continued their dramatic climb.

If you had foreseen all of these trends, you probably would have made above-average profits in the stock market. Chances are, though, that your crystal ball was on the fritz.

Usually, everyone's is. The economy is so vast and complex that few people, if any, can accurately predict its direction.

The results of my annual Derby of Economic Forecasting Talent provide some evidence of what a difficult task it is.

Three people tied for first place this year in the seventh annual Derby. They were Allen Hoppe, principal financial analyst for the Metropolitan Council (a seven-county governmental organization) in St. Paul, Minnesota; Gibran Lalani, an associate at municipal-bond insurer CIFG Services Inc. in New York; and Jim Peterson, a real-estate agent at Re/Max Southeast Inc. in Denver.

The contest calls for participants to predict six economic variables: gross domestic product, inflation, interest rates, oil prices, retail sales and unemployment.

Each of the winners beat the rest of the field in predicting one variable. None of them got points for getting any of the other five variables right.

My scoring system allots 3 points for finishing first on any of the six questions, 2 points for second and 1 for third. Theoretically, a perfect score is 18.

Low-scoring contest

In practice, the winning score is often 4 to 6. This year, the three winners each scored 3.

Of the 121 people who entered the contest, the biggest group consisted of investment managers. There was also a sizeable contingent of professional traders.

In contrast to past years, only a few economists entered this year, and very few stockbrokers. Quite a few bankers entered. There was a healthy sprinkling of doctors and lawyers, both active and retired.

Others included an airline pilot, a plumbing contractor, a rabbi, several insurance and real-estate professionals, a mining engineer, a couple of unemployed people, several retirees and a couple of city officials.

The difficulty of forecasting multiple economic variables has been demonstrated in numerous other forums. For example, the Wall Street Journal regularly publishes surveys of economists' forecasts.

In reading the Journal surveys over the years, I conclude that few economists, if any, are consistently good at the prediction game. Most are taken by surprise when there is a major change, such as the surge in oil prices the past three years.

The six questions

Let's have a look at those six variables that contestants had to grapple with.

First, they had to predict GDP growth from July 2005 through July 2006. Currently, the Commerce Department's figures show 3.5 percent year-over-year growth.

Most contestants guessed that growth would slow. Perhaps they expected the Federal Reserve's raising of interest rates to bite sooner and harder than it did.

Second, the players had to forecast the year-over-year change in inflation, as measured by the Consumer Price Index. Because inflation has been subdued in recent years, almost everyone guessed too low.

Actual inflation was 4.8 percent (as Hoppe forecast). More than 90 percent of the participants picked a lower figure. It's hard to anticipate a change in the wind, yet that is precisely the kind of prediction needed to make money in stocks.

Third, people were asked to say where interest rates would be, as measured by the 10-year Treasury bond. As of Aug. 25 (the contest's end date), the 10-year bond offered a yield of 4.78 percent.

Relentless oil

Contestants did pretty well on the interest-rate question. The majority correctly predicted that borrowing costs would rise in the 12 months just ended.

Fourth, people had to guess whether the price of a barrel of oil -- which had already climbed to $66.13 a year ago from $30.54 two years before -- would continue to escalate.

The majority said oil prices would subside. In fact, they rose 9 percent to $72.13 a barrel as of Aug. 25.

For their fifth trick, contestants had to guess total retail sales for July 2006. The right answer was $367.9 billion. Many people got the general drift, which was that retail sales rose modestly from the year before.

Sixth and finally, participants needed to guess what the unemployment rate would be as of July 2006. Most people were too gloomy, guessing anywhere from 5.1 percent to 8.2 percent. The actual figure was 4.8 percent.

Dorfman, president of Thunderstorm Capital in Boston, is a Bloomberg News columnist.

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