Federal Reserve officials are great at making forecasts. Unfortunately, their forecasts aren't always very good. That's probably why their forecasts attract so much attention.
Earlier this week, John Williams, the president of the San Francisco Federal Reserve Bank, said, "The stock market seems to be running pretty much on fumes. It's something that clearly is a risk to the U.S. economy, some correction there -- it's something we have to be prepared for to respond to if it does happen."
This can be read as a warning from a Fed president that stocks are due for a decline. This is the latest in a long line of stock market forecasts from the Fed.
The most famous warning that stocks could fall probably came from former Fed chairman Alan Greenspan in December 1996. Greenspan said, "Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"
Greenspan's fears eventually came true when the market crashed in 2000, but that was nearly four years after his original prediction. And during those four years, the market more than doubled in value. I wouldn't want to be an investor who sat on the sidelines during that prolonged run-up.
If stocks continue higher, Williams' "running on fumes" analogy could join "irrational exuberance" on the list of predictions the Fed got wrong.
Skeptics ask if we can really trust the Fed to get policy right when they make such bad stock market forecasts. The truth is the Fed might actually be pretty bad at what it does since it almost always tends to increase interest rates until the economy tumbles into a recession. But, despite its shortcomings, I think the Fed is better than the alternatives.
After all, even stock market analysts who are experts in the companies they cover tend to get forecasts wrong. To some degree, forecasting is an exercise in drawing conclusions from the past. That's what Williams and Greenspan did. They both compared current valuations with historical valuations and declared the current level "too high."
Before the Fed, the economy was on a deep boom-and-bust cycle. Recessions were common and deep. Since the Fed found its footing after World War II, recessions have been relatively rare and shallow.
However, even though the Fed does a good job managing the business cycle, Fed officials are not stock market experts. They tend to understand this and accept that the market is just one part of the economy. Their focus is on minimizing inflation and unemployment; for us, it's probably best to ignore their market forecasts.
Analysts tend to do the same thing. They expect trends in earnings to continue and they develop estimates based on historical experience along with knowledge about the current operating environment.
Editor's Note: I think Amber is right in her assessment here. If you think the market is overheated, well guess what, it probably is. But that doesn't mean it'll correct overnight. If what you're doing is working, then stick to the plan.
That's exactly what Amber and her followers over at Income Trader are doing. By using her conservative plan, Amber's readers are earning hundreds (sometimes thousands) of dollars with every simple option trade they make.
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This article originally appeared on Street Authority.