Summary of Economic Projections (SEP)

The Summary of Economic Projections (SEP) is a quarterly report released by the U.S. Federal Reserve. Think of it as the Fed's “report card” on the economy's future. It compiles the forecasts of each member of the Federal Open Market Committee (FOMC)—the group that decides on U.S. monetary policy—for several key economic indicators. These include economic growth (GDP), the unemployment rate, and inflation. The SEP is released four times a year (in March, June, September, and December) alongside the FOMC's policy statement. For investors, the SEP is a treasure trove of information, offering a glimpse into the minds of the people steering the world's most influential central bank. It provides crucial context for understanding how the Fed might adjust interest rates in the future, which has a ripple effect across the entire financial world, from bond yields to stock market valuations.

The SEP is more than just a single document; it’s a collection of forecasts about where the economy is headed. While it contains a range of data, investors typically zero in on the projections for four key variables:

• Real GDP Growth: This is the forecast for how much the economy will grow, adjusted for inflation. Stronger GDP growth is generally good for corporate profits, while slowing growth can be a headwind.
• Unemployment Rate: The Fed's projection for the percentage of the labor force that is jobless. The Fed has a dual mandate to aim for both stable prices and maximum employment, so this number is critical to its policy decisions.
• PCE Inflation: The Fed’s preferred measure of inflation is the Personal Consumption Expenditures (PCE) price index. The SEP shows where policymakers see inflation heading, which heavily influences their decisions on interest rates. Their official target is 2% inflation.
• Federal Funds Rate: This is the big one for markets. The report projects the “appropriate” path for the Federal Funds Rate, the central bank's key policy tool. This is visualized in a chart that has become famous in its own right: the “dot plot.”

If the SEP were a blockbuster movie, the dot plot would be the main star. It’s the part of the report that generates the most headlines and market chatter.

The dot plot is a simple chart that packs a powerful punch. It graphically represents where each of the FOMC members (anonymously) believes the Federal Funds Rate should be at the end of the current year, the next couple of years, and in the longer run. Each dot represents the view of one policymaker. It's crucial to understand that the dot plot is not an official policy promise or a formal committee forecast. Instead, it’s a snapshot of the individual opinions of the participants at a specific moment in time. Think of it as a survey of the committee's collective “best guess” on the future path of interest rates.

Markets hang on every new dot plot because it provides one of the clearest signals about the Fed’s future intentions.

• Gauging the Fed's Mood: The median dot—the one in the middle of all the projections—is often interpreted as the committee's baseline view. If the median dot moves higher compared to the last SEP, it signals a more “hawkish” Fed, one that is more inclined to raise rates to combat inflation. If it moves lower, it suggests a more “dovish” stance, leaning toward cutting rates to support economic growth.
• Informing Valuations: The expected path of interest rates is a fundamental input for valuing almost every asset. Higher future rates generally mean higher borrowing costs for companies and a higher discount rate for investors, which can put downward pressure on stock prices. The dot plot gives investors a framework for these expectations.

A wise value investing practitioner, channeling the spirit of Benjamin Graham, treats the SEP with a healthy dose of skepticism. While it’s a valuable tool for understanding the macroeconomic climate, it’s not a crystal ball. Remember, even the world's top economists frequently get their forecasts wrong! The primary focus for a value investor should always remain on analyzing individual businesses and determining their intrinsic value. So, how can you use it?

• Context, Not Command: Use the SEP's projections to understand the economic environment a company operates in. Are rising interest rates going to squeeze its profit margins? Is slowing GDP growth going to dampen its sales? The SEP provides the backdrop for your company-specific analysis.
• Refining Your Models: The projected path of the Federal Funds Rate can serve as a sensible input when determining the discount rate in a discounted cash flow (DCF) analysis. A higher expected interest rate path generally means you should use a higher discount rate, which will lower the present value of a company's future cash flows.
• Reinforcing Your Margin of Safety: The uncertainty inherent in these projections underscores the importance of demanding a margin of safety. Since the economic future is unknowable and the Fed's own forecasts can be wrong, always buy a stock for significantly less than your estimate of its intrinsic value. This buffer protects you from forecasting errors—both yours and the Fed's.