'Economist' may break its own track record in making dire predictions

LONDON BRIEFING: The Economist has caused a furore in Britain with its most recent forecast that there will probably be a house price crash, writes Chris Johns

Its apocalyptic vision of house prices applies not just to UK property but also to real estate in other countries, including the Netherlands and Ireland. Britain's tabloid newspapers, most notably the Daily Express, have repeated the Economist's claims with their usual calm and restraint.

The Economist has quite a track record of making predictions that go badly awry. It once forecast a collapse in the cost of oil - with an explicit target of $5 per barrel - that marked, perfectly, the start of a long upswing in oil prices. The newspaper still thinks that equity prices are set for steep falls - it never mentions the words "stock market" without saying "overvalued" - and has studiously ignored the recovery in global equity prices this year.

The business of making forecasts always runs these kinds of risk and always invites derision when things go wrong. The Economist should not be criticised for speculating about the future. Where the newspaper is making a huge mistake is where it dresses up subjective opinion and represents it as objective fact. This is a trap which used to be studiously avoided by such an august journal and represents a sad decline in the quality of British financial journalism.

Business Week, arguably the Economist's main global contender, has a much more approachable style, perhaps even slightly tabloid, but the reader always is aware of the difference between opinions and established facts.

Take the prediction about house prices. The Economist's analysis is based mostly on a comparison with the valuation of company shares. The newspaper points out that houses and equities can be valued using the same technique. That much is absolutely true. The argument is then couched in terms of "PE" ratios (equity prices divided by corporate earnings). When PE ratios are "high", shares are expensive and should be sold. An equivalent ratio for house prices is then calculated, which is argued to be "high", justifying the forecast of a property crash.

The trouble with all of this is that it assumes that we know with precision the correct PE ratio for a company or a house. The truth is that we only have a rough idea. In order to know the true value of a company, we need to know a lot of things, including such non-trivial items as the firm's return on capital (forever) and its cost of capital (forever). If any of this was easy, the business of making money by investing in the stock market would be a piece of cake.

Analogously, for property, we need to know what rental income a house will bring in (forever) and what a mortgage will cost - yes, you guessed it - forever. Anybody who professes to know with certainty any or all of this is a charlatan. We can have opinions, but don't pretend that they have sturdy, objective roots. House prices depend on lots of things, about which we can have guesses but they are no more than that. Demographics, interest rates and the state of the job market are all important and all very hard to forecast.

The decline in the quality of the writing in the Economist is a pity. British journalism has little to commend it these days. Even the venerable Financial Times seems to be losing its battle with the Wall Street Journal. In the US, the FT has failed to offer a serious competitive challenge. In Europe, business coverage for individual company stories and financial markets is immeasurably better in the WSJ. The FT is still trapped in a rather parochial UK-centric view of the world.

The way in which the UK media has handled the debate over housing is a missed opportunity. Stock market news fills acres of newsprint on a daily basis and is available continuously on the web. But one of the things that we have learned over the past few years is that the behaviour of the property market is at least as important as the equity market for the broader economy.

It is surely no coincidence that German and Japanese property prices have been falling for years, while the US and UK housing markets have remained resilient. If the Economist's analysis of the property market was hopeless, it was nevertheless right to devote so much attention to something that is probably much more important than we realise. Property prices tell us a lot - much more than stock markets - about the behaviour of our economies.

The Economist has missed the point. If house prices are about to collapse in the UK, then so will the economy.

That is as true of Britain as it is of the US and Ireland. It is dishonest to forecast one without the other.