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Volatility in the markets: the difficulty of crystal ball gazing

Author: Simon Glyn
6 September 2010

Simon Glyn, partner at specialist restructuring, recovery and insolvency firm, FRP Advisory LLP, analyses market forecasts from members of the financial community and what impact a volatile economy has on business planning.

At the end of the 2009/2010 tax year, FRP Advisory asked a number of banking contacts for their predictions on the movement in market measures in the three months to the end of July. They were asked about the four measures of FTSE 100 growth, £-$ rate, barrel of Brent crude oil cost and GDP growth for April-June 2010.

On reviewing the predictions versus actual outcomes, a large number of respondents’ forecasts varied significantly from actuals; even broader trend predictions, with a wider margin of error, often proved flawed. This has highlighted the volatility of the markets and the potential pitfalls of relying too heavily on predictions to shape business plans.

In terms of the FTSE 100, 97% of respondents felt that the FTSE would be higher than the end of July figure. However, it fell from 5,729 to 5,258 during the three month period, with sovereign debt concerns weighing far heavier on the market than had previously been anticipated.

The £-$ rate stayed relatively stable, moving from $1.53 to $1.56. While most respondents were generally close to these figures, 37% predicted the rate to fall slightly rather than increase.

In addition, a barrel of Brent crude oil decreased from $83 to $78 during the three months, despite 87% of predictions expecting the price to increase – although this may reflect our perception as consumers of petrol that the oil price only seems to move upwards.

The GDP growth during April-June 2010 was truly unexpected. While 97% of respondents predicted a lower outcome than the 1.1% seen, a huge 84% thought the growth would be between 0 and 0.6%. Although this was also a surprise for most economic commentators; their short-term predictions indicate this figure is somewhat of a blip and will not be sustainable, particularly given autumn’s expected public sector cuts.

The results highlight the variation in accuracy when it comes to predictions in a volatile market. In this sort of environment, with a very tentative recovery and the possibility of a double-dip recession, it is likely that lenders will remain cautious. Their own risk management practices will stipulate a very measured approach to lending as, in the aftermath of the credit crunch, the banks are still under pressure to maintain a cushion of liquidity that could reasonably withstand another financial shock.

Owner managers must build macroeconomic predictions into their own forecasting, but the degree to which these factors are changing in the current climate heightens the importance of contingency planning. A significant margin for error must be incorporated into business plans, particularly cash flow forecasts where unforeseen circumstances can have the most devastating effect.

This does not mean predictions can or should be ignored - managers need to solicit as much advice as possible and take on board expert forecasts: the differences between forecasts will provide some guidance when strategically planning. A volatile market is undoubtedly more difficult to navigate, however it also presents opportunities. Only by developing the most accurate picture possible, can rewards and pitfalls be identified and plans put in place to ensure the best possible outcome for the business.

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