For the life of me I can’t understand Wall Street’s obsession with forecasts. These guys will forecast anything, like prop bets for the Super Bowl. It’s out of control! Regular readers know how I feel about forecasts, but for the uninitiated, Wall Street forecasts are the equivalent of fortune telling: a lot of pomp and circumstance but absolutely zero real value.
Wall Street has two particular favorite fortune telling games. The first happens each January, when strategists love forecasting where the S&P 500 is going to finish the year. In the second game, analysts forecast which companies will be winners and which will be dogs in the coming year.
Like Mike Tyson said, “Everyone has a plan ‘til they get punched in the mouth.” When the S&P closes at brand new all-time highs once every five trading days, these already worthless forecasts get shredded like a document in the final hours at Enron.
Ace of Coins
You know it’s the start of a new trading year when strategists from Wall Street and foreign banks tell you precisely where the S&P 500 will end the year. There is zero informational value in these price forecasts, and frankly, I don’t even see the entertainment value.
I’ve never seen a single strategist for a major bank or Wall Street firm forecast a decline for the S&P. Not one! This year was no different, with eighteen strategists channeling their inner Miss Cleo and each one predicting the S&P would gain ground this year. Shocker!
These strategists’ upside profit targets ranged from a “whimper” at $2,275 to a “party like it’s 1999” forecast of $2,500. Hindsight tells us that all of these fortune tellers underestimated just how high accelerating U.S. growth would push the S&P.
On the low end, Andrew Garthwaite’s (Credit Suisse) forecast of $2,275 was left in the dust even before January was over. At the high end, Jonathan Golub’s (RBC) forecast of $2,500 was left in the rearview in September.
The S&P is now 240 basis points above even the most optimistic price target!
If you’re using year-end forecasts from January as part of your process, may I suggest a tarot card reading?
At least that way, when you get The Wheel of Fortune card coupled with the Temperance card, you’ll know “you’re not far from harvesting the fruits of your labor and your endurance. You might be in for a bonus.” Ka-Ching!
Even when these guys take a mulligan and revise their forecasts during the year, they provide the research equivalent of a poop emoji.
For example, David Kostin (Goldman Sachs) said last week that if there is no U.S. tax reform, then he stands by his January $2,400 year-end S&P price target. He went on to provide a second year-end forecast of $2,650 based on the scenario of an approved tax reform. Bottom line is Kostin thinks the S&P is either going to fall 6% or gain another 3.5% over the next two months depending entirely on Trump’s tax reform.
Kostin provides a detailed matrix explaining how he arrived at the new price target, but honestly, it doesn’t matter. This is because the most important variables impacting asset prices are economic conditions and how central banks respond to those conditions. Tax reform could have a meaningful impact on U.S. economic conditions, but not in the next two months.
If you’re using revised year-end forecasts based on political footballs as part of your process, may I suggest getting your palm read? You may find that your money lines (the upright lines located under the ring and little fingers) are deep, clear and straight. My friends, this kind of money line means “you’re smart, good at investing and could make a fortune.” Boo-yah!
In addition to year-end price targets, Wall Street analysts love to forecast which stocks will out- or underperform the broader market. To steal a line from Gordon Gekko, “They're analysts, they don't know preferred stock from livestock.”
Last December, The Economist conducted a study of all the equity analyst ratings for the 500 companies in the S&P 500 index. The study found that 49% of all the ratings were "buy/outperform,” 45% were "hold/neutral,” and the final 6% were ratings of "sell/underperform."
Despite these analysts’ “insights,” 50% of the stocks in the S&P underperformed the index last year and 30% delivered outright negative returns. Rather than just 6% of the S&P 500 universe deserving a “sell” or “underperform” rating, a full 80% of the companies fit these two descriptions. But what’s a 74% forecasting error between friends?
This study covers just one year, but it’s by no means cherry-picking. It simply highlights that analysts don’t have a clue which companies will perform well and which ones should have been left on your portfolio’s bench.
If you’re using analysts’ ratings as part of your process, may I suggest you read your horoscope instead?
For instance, this week if you’re a Virgo, “Aspects are expanding your opportunities at work and paving the way for a raise, promotion, or both. Even on a bad day, you're pretty lucky. These days money is coming so fast and furious that you may need a new plan for saving and investing.” Tah-dah!
The Bottom Line
With all the technology and sophistication today, weather can’t be accurately predicted further than three days into the future. If we can’t accurately predict weather further out than seventy-two hours, then what makes us think anyone can accurately predict something as complex as financial markets months into the future?
Being a consistently successful investor requires that you better understand what is happening right now with regards to the trends in economic and financial market data. Period. As always, stay data dependent, process driven and risk conscious, my friends.