It’s that time of the year again. Of course, I’m talking about Prediction Season. The time of the year where market strategists at all of the largest investment banks participate in the annual ritual of publishing their predictions for the returns of the S&P 500 Index over the next year.
Generally, these forecasts garner quite a bit of media attention in the press and on the financial news talk shows. On any given day at this time of the year, we’re likely to see least one of these market strategists on TV elaborating on the logic and rationale behind their precise forecasts for what we can expect in the year ahead. I’ll readily admit that every single one of them is exceptionally articulate and their reasoning appears unassailable. After all, these market strategists are among the brightest minds on Wall Street and are backed by the immense depth of their respective firms’ full roster of resources, computational might and unrivaled access to the leaders of the corporate and government sectors who are in “the know.”
Nevertheless, a very real question remains: should we as serious, evidence-based, long-term investors put much faith in these forecasts and rely on them to influence our investment decisions? Fortunately, it’s easy enough to turn to the data to help guide us to an answer.
In the chart below, relying on data from Natixis, we plot the average of these strategists’ annual S&P 500 Index return forecasts for each year beginning in 2000 including the strategists’ most recently published forecasts for 2019’s returns.
A few observations:
- The average of the forecasts called for positive returns every year.
- The range of the average of the strategists’ forecasts was relatively narrow with the annual forecast predicting gains between 4% and 11% in all but three years.
- On average, the forecasts predicted annual returns of 8.7%—interestingly close to the index’s long-term return.
Next, we plot the actual returns calendar year returns for the S&P 500 Index including 2018 through the market’s close on December 18.
A few more observations:
- The index experienced both positive and negative years (reminding me of the venerable former Chairman of Bear Sterns, Ace Greenberg’s testimony to the Senate in the late 1980s: “Stocks fluctuate”).
- The range of annual returns was quite wide, ranging from a low of –38% in 2008 to a high of +30% in 2013.
- Very rarely were the actual annual returns close to what most would consider to be “average” (i.e., 10%, give or take a few percentage points).
And lastly, the chart below presents the margin of error of the strategists’ forecasts in each year (i.e. difference between the strategists’ average forecast and the index’s actual return).
A cursory glance at the chart quickly reveals that on average, these forecasts have been wildly inaccurate. We can see that the strategists’ forecasts came within two percentage points of the actual returns just twice. If we expand our threshold of “correct” to include those years where the forecasts came within five percentage points of the actual result, we pick up an additional four years giving us six years total—still not very good in my book against a decidedly low bar. We can further see that the strategists’ errors were in both directions—they were overly optimistic in some years or failed to predict a coming downturn and in other years they weren’t optimistic enough and significantly underestimated the strength of a positive year.
On average, the strategists’ average forecast missed the mark by 14 percentage points during the 19 years for which we have data against which to compare the forecasts. Amazingly, if the strategists were to have blindly assumed that the S&P would go up by 9% each year (roughly in line the index’s long-term average annual gain, depending on the exact start and end date chosen), the average margin of error in any given year would have been smaller that it was when they updated their predictions every year based on their latest analysis!
Thus, a cold, rational analysis of the data suggests that serious investors are wise to ignore the siren song of these annual predictions the entice all of us with the enchanting possibility that we can divine the inherently unknowable future. The unfortunately reality is that the markets routinely have a way of humbling those who believe they can consistently predict their short-term movements.
Rather than constantly searching for a crystal ball to help identify emerging investment risks and opportunities and incessantly trying to capitalize on them—which often leads to the perverse tendency to buy high and sell low, exactly the opposite of what successful investing looks like—we believe a far more prudent strategy for achieving long-term investment success is one that relies on diversification and long-term discipline that’s guided by empirical research and evidence on financial markets, asset pricing and expected returns. We believe investors greatly increase their chances of long-term success if they hold a thoughtfully diversified portfolio that’s designed explicitly with their unique goals in mind and is constructed within the very real constraints imposed by each individual’s time horizon and unique attitude and perspective toward risk. We are passionate about helping our clients do just that as well as to maintain the discipline and internal fortitude to hold on during the inevitable rough patches that will come about along the way.
If you’re not sure that your portfolio is properly calibrated to you and your goals and risk tolerance or even if you’re not all that clear on exactly what your goals and risk tolerance are, please don’t hesitate to contact us. It’s what we’re here for. We’d love to talk.
I’ll leave you with one of my favorites from Warren Buffett who once described the value of short-term predictions as follows: "Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future."
Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All investing involves risk including loss of principal. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.