“It’s not easy to be as bad as they are. They are much worse than random chance alone would predict.” Salil Mehta, Statistical Ideas
The annual charade of forecasting is upon us. Financial institutions look into their crystal balls and tell us what lies ahead for the stock market. It usually sounds something like this:
“Stocks should peak in the first half of next year, with the S&P hitting 2,750, but then turn volatile as the market begins to sniff out a recession.”– Actual 2018 forecast from unnamed Wall Street firm
Not surprisingly, Wall Street’s forecasting track record is abysmal and follows a perma-optimistic tone. According to Bespoke Investment Group, the Wall Street consensus has predicted a rising market every year since 2000. Like the point and drag function in Excel, our friends on Wall Street predict a perpetually appreciating stock market.
In 2001, the consensus called for a gain of 20.7 percent. The index fell by 13 percent. In the horrible year of 2008, the consensus predicted the market would rise 11.1 percent. The index lost ~39%. Ouch.
This begs the question; why are Wall Street forecasts so awful?
Optimistic predictionsencourage investors to add money to their investment accounts. More assets under management equals more profit. That’s why negative market predictions are so rare for Wall Street. They don’t want to spook their clients and trigger outflows. We challenge our readers to find a negative 2018 S&P forecast from a major Wall Street firm.
There is no penalty for being wrongwhich often encourages oddly precise (quote above) or outlandish forecasts. For example, the analyst that predicts the S&P 500 to return 4% next year doesn’t garner much attention. However, if the same analyst said the S&P 500 would appreciate 40% by April 2018 that would generate significant media buzz.
Story-Based Advisorscan spin anything. We were recently reminded of a large money managers 2016 market prediction. At the beginning of the year, the firm published a return expectation of +18% for the S&P 500. After an ugly January, the revised forecast called for a loss of ~11%. By summer, the market had rebounded and the forecast was revised yet again to +2.7%. The firm did a great job of telling us what just happened, but offered nothing of value.
We are not saying people shouldn’t forecast. Rather, if the system was better aligned to promote responsible forecasting than click-bait headlines, investors would be better off. For example, what if your broker cut fees by 40% for being wildly wrong on their 2018 S&P 500 target? You wouldn’t see meaningless absolute targets like “the S&P will fall by 5% in the spring and rebound to 2,800 in the fall.”
This is wishful thinking with zero likelihood of happening, however, you would see an evolution in the process of forecasting. In our opinion, these are sound principles to start with:
Ditch the annual prediction charade. The market doesn’t care about an arbitrary date on the calendar and neither should we.
Accept that investing is hard and no one is right 100% of the time. Show some humility…it’s okay to say, “I don’t know.”
Focus on a broad range of outcomes; both positive and negative. You can assign probabilities to potential outcomes to frame a base expectation. A sound process will increase the likelihood of making good investment decisions.
Wall Street forecasts offer little predictive value. Do yourself a favor and ignore the perpetually rosy predictions for 2018. As evidence-based investors, we refuse to engage in such a futile exercise.