The ISM Manufacturing Index level is released once per month and provides a gauge for U.S. factory output. Readings above 50 signal expansion, while readings below 50 signal contraction.

Leading up to the June 2011 report (released on July 1), economic forecasters had become increasingly discouraged as signs of an economic slowdown emerged. The 77 economists surveyed by Bloomberg provided a range of estimates for the June Index level landing between 49 and 55, with an average of 52. The actual number came in at 55.3. Not only was it a fairly large miss relative to the average guess, but the actual index level came in outside of the entire range of the forecasts. Talk about a miss!

Given the better than expected news, the S&P 500 stock index jumped 1.44% that day.

Six days later, Automatic Data Processing, Inc. released the ADP Employment Report. This report seeks to provide insight on job growth/contraction in the U.S. private sector. It is also viewed by many as a preview of the more expansive Employment Situation report released each month by the U.S. Bureau of Labor and Statistics (BLS). While one could argue that the ADP data is consistent with the BLS over longer periods of time, the fact is that there is little consistency between the monthly data.

Nonetheless, when the ADP report came in much better than expected, investors grasped onto the optimistic message. The combined impact of potentially stronger job growth and the healthy manufacturing data the week before sent the S&P 500 up again, with another 1.05% gain.

The following day, July 8, the BLS report was released and it was a stunner, but not the way economists had been expecting. Yet again, the key data point (non-farm payroll growth) landed outside the full range of estimates, coming in at 18,000 vs. a forecast of 65,000-160,000. Not surprisingly, stocks plunged in the morning but recovered somewhat by the end of the day. The S&P 500 finished with a decline of -0.7%.

Just what is going on here? Why are the forecasts so far off the mark and why does this lead to such volatile market conditions?

To be blunt, the track record of economic forecasting is terrible. Not just in the short-term as noted above, but in the long-term as well. Sure, some individual forecasters will be better than others (good luck figuring out which ones, though!), but as a group, economic forecasters have shown very little ability to predict meaningful turning points in the economy. For example, they have never forecast a recession in the U.S. (see graph from James Montier of GMO, LLC below).  You may have lived through a handful of recessions yourself and probably would like to have been given a few months notice on them, but the forecasters haven’t been able to do that in a single instance. By the time that many of them agree that a recession is taking place, it’s usually close to being over.

So why do investors keep paying attention to these forecasts, pushing stocks to and fro based on the latest hit or miss? That is a great question that we don’t understand well enough to answer. We can, however, provide a recommendation for investors that is very powerful in general and in this specific case: focus on what YOU can control. We’ve just told you that a massive amount of time and resources are wasted every day on economic forecasting and that investors mistakenly rely on those forecasts to make investing decisions, possibly increasing volatility in the financial markets. Those of us who recognize this problem may wish it weren’t so, but the actions of others are not in our control. What we can control is how we respond to these situations. So what if others are making poor decisions? Let them! You don’t have to follow their lead. Recognizing the mistakes that others make is a much less painful method of learning than making the mistakes yourself.

Ignoring the forecasters may be your best move. Not only will it keep you from making the same mistakes, it will also reduce the aggravation of constantly trying to figure out when and if you’re supposed to be changing course with your investments.

P.S. The focus on short-term economic data is often much more unfounded than implied above. This is because even the reported results are not known with certainty. For example, a reported data point for a single month might be reported as +50,000, but what you won’t find in most media stories is that the sampling error might be +/- 100,000. In other words, there is actually very little confidence that +50,000 is even the true data point! To make investment decisions based on such information appears to be pure folly, yet it happens every day.

PLEASE NOTE: The S&P 500 Index is an unmanaged index comprised of 500 stocks of large U.S. companies, representing many industries.  It is a common measure of the performance of the overall U.S. stock market. Indexes are unmanaged, and it is not possible to invest directly in an index. Past performance is not a guarantee of future results.