December brings an extraordinary number of prognostications from strategists and economists about the year to come. They tend to make for good reading – but don’t act on even one word of it.
Most of the predictions boil down to a single number: Where the S&P 500 or the S&P/TSX composite index will end the year. Amazingly, few forecasters ever see a down year. Equally amazing, most predictions stick close to the average stock market gain through history, about 8 per cent.
According to the two dozen strategists tracked by Business Insider last year, the average forecaster saw a gain of 8.6 per cent for the S&P 500 in 2012. With about three weeks left in the year, the index is on track for a 13.5 per cent gain, making the average strategist look a touch too conservative.
Most strategists can probably live with that – after all, getting the direction of the stock market right is more than half the battle. But in many years, forecasts tend to be laughably off base simply because the stock market is unpredictable in the short term.
“These stock market predictions for 12 months from now are formed through the scientific process of extrapolating conditions from the present and recent past, stirring in some cognitively dissonant assumptions, adding a pinch of wishful thinking and then garnishing with a dollop of political bias,” said Josh Brown, a blogger at The Reformed Broker.
According to the Financial Times, drawing on Bloomberg data going back 13 years, the average stock market forecast has been off by about 10 per cent.
Even that might be overstating the success rate of forecasts, particularly in years when stocks swing wildly. In 2008, the average strategist certainly didn’t predict the 38 per cent dive by the S&P 500.
Strategists did better in 2009, but the average forecast of a 13 per cent gain lagged the actual return that year by more than 10 percentage points. The index was unchanged in 2011, but strategists had thought it would rise 9 per cent.
For 2013, strategists again see opportunities ahead, with an average target of 1540 for the S&P 500.
Bank of America predicts the S&P 500 will hit 1600 as corporate earnings chug higher. If correct, the index would hit a new record high with a gain of about 12 per cent from current levels. Bank of Montreal sees the index rising to 1575 as investors start to pay more for earnings.
No doubt, the strategists making such forecasts are intellectual heavyweights with an amazing grasp of economics and a thorough understanding of how markets work. Reading their forecasts for the year ahead can give investors a good understanding of the big foreseeable themes.
The problem is, markets often react on the unforeseeable – the surprise credit rating downgrade, the sudden turn in earnings that no one saw coming, a lending freeze.
Forecasts are nice, and a few of them even turn out to be correct. But they are no replacement for a properly structured portfolio that can withstand the market’s unpredictable nature.