Analyst Forecasts: Lessons in Futility
The year 2018 is coming to a close and with it the endless reports on strategists’ stock market forecasts for the coming year. And rest assured, just like every year, someone is going to ask me where the FTSE 100 or the S&P 500 is going to be at the end of 2019.
It is common knowledge that all forecasts are wrong, but many investors still think forecasting one-year stock returns is a useful exercise. When it comes to long-term forecasts, there might be some value in them, but return forecasts over time frames like one year or less are extremely unreliable. In fact, anyone who uses these forecasts for investment decisions should seriously reconsider their investment process.
Let’s take, for instance, the forecasts made for stock markets at the beginning of 2018 by strategists from prominent banks around the world. For the S&P 500, the median forecast price at the end of 2018 was 2950 points, for a 2018 calendar year return of 10.3%. As of this writing, the realized return for 2018 was -7.71%. Analysts were overly optimistic going into this year and the difference between forecast and realized return was about 18 percentage points.
In Europe, the situation is comparably awful. Strategists expected a 1.5% annual return for the FTSE 100 at the beginning of the year, but at the moment the realized return is -12.69%. For the EuroStoxx 50, the predicted return was 7% and currently stands at -14.38%. That’s an estimation error of more than 21 percentage points and a buy recommendation at the beginning of the year for eurozone stocks because they would do exceptionally well when in truth they lost money for investors.
And yet the picture for 2018 is not a particularly disastrous one. Strategist forecasts for the S&P 500 have been off by more than 10 percentage points in 13 of the last 20 years! Strategists can be happy if they call the direction of stock markets correctly. For the S&P 500, strategists got the direction wrong in 11 of the last 20 years. They were right only nine times out of 20. So, if they are basically no better than the flip of a coin when predicting the direction, why would anyone expect them to call both the size of the move as well as the direction? Anybody who sees this track record and still wants to know what the year-end target of the stock market is should have his or her head examined.
To be clear, I don’t claim that I can predict the stock markets any better than my colleagues who contributed to these forecasts. But why should any investor waste time with such futile exercises? Anyone who claims to be able to predict stock markets over the coming year is, in my view, a charlatan selling snake oil. As William J. Bernstein observed: “The reason that ‘guru’ is such a popular word is because ‘charlatan’ is so hard to spell.”
And speaking of charlatans: Have a look at the forecasts of cryptocurrency “experts” and “gurus” for the year 2018. There is a website where someone apparently wanted to build a career by predicting crypto returns.
Bitcoin at year-end 2018 was predicted to be at $75,000 (560% return) and $750,000 (1000% return) at year-end 2019. As of this writing, bitcoin stands at $4,107.42 (-70% return). The Ethereum year-end forecast was for $11,000 (819% return) at the close of 2018. Today, it’s at $114.62 (-86% return). Ripple was supposed to end the year at $3.50 (161% return) but instead trades at $0.37 (-81% return).
This is a level of forecasting error that should ban these forecasters from your inbox for life.
For more from Joachim Klement, CFA, don’t miss Risk Profiling and Tolerance, from the CFA Institute Research Foundation, and sign up for his regular commentary at Klement on Investing.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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6 thoughts on “Analyst Forecasts: Lessons in Futility”
Heck predicting stock % returns is impossible because it includes the overlay of sentiment driving valuation. Even the analysts’ predictions of $earnings’ growth is always waaaaaay off. Yet the media almost always quotes numbers that have those predictions built in invisibly.
Eg at the end of Mch 2018, when all the year end data were published and absorbed, but before the Q1 info started leaking, the S&P published earnings estimates were for 32% growth. Using their estimates for Q4, the actual earnings growth was only 15%. http://ca.spindices.com/documents/additional-material/sp-500-eps-est.xlsx?force_download=true
And this is always the reality. The industry is a cheerleader and not to be taken seriously.
Totally agree. Every stock is a strong buy and every market is a raging bull.
Forecasting the future, especially a year ahead, is inherently difficult and some may say, impossible, because it relies on conditions for the prescribed scenario happening. This seldom happens and as we know, no battle plan survives contact with the enemy. World events get in the way.
What is needed is understanding of the connections between cause and effect and how events will impact markets upon receipt of new information. No-one knows what is going to happen to oil and commodity prices, trade disputes, war, volcanic activity, epidemics etc. etc.
Fund managers and analysts might think they live in a world of certainly and control but it can be argued that they do not. They have no control over index values or what happens to individual stock prices nor certainly as to what is going to impact them and by how much.
So, what is the solution? Scenarios should be modeled to see what the results would be. Oil at $30, oil at $150, Mexico border shut, 10% inflation in the US, hard Brexit, FED and ECB tightening, Italy defaulting on debt, fully floating Renmimbi etc etc. None of these things might happen but at least if the models exist then key milestones which give clues about the developing story will be available.
Confessing after the event what “we never thought it would happen so we did no scenarios around it” never looks clever.
“If you aren’t willing to own a stock for ten years, don’t even think about owning ….. Warren Buffett
A lot of things happen in an economy which can effect the market within a period of time.
A stock that performed badly in one year could turn out to be the best performing stock in 3 to 5 years depending on the events that took place within that period.
Making a decision based on one year analysis could turn out to be the worst ever decision you have made.
In today’s industry age, systemic thinking and scenario analysis increase depth of field when going through forecasts. And when we consider many moving parts in financial market, we will discover the important role of such approach in investment industry.
Let’s take a scenario into consideration.
Year 2020, forward looking analysis by some financial institutions disclosed recession is undeniable. Central banks started housekeeping for such probable event with foreseen impacts. The recession would be developed as a result of banks shortage of liquidity. And proliferation and speed of information provides an efficient foundation for news.
In such economic condition, price levels and unemployment rate increase. Economic activity has to be boosted to bring aggregate output and price levels back to equilibrium. And for such event to be happened, monatory and fiscal policies are two legs tool in hand. Considering pessimistic consumers’ expectations, marginal propensity to save would take the lead. This could be thought of an opportunity to feed business sector indirectly. And in order to strengthen collectiblity, strategists’ reports show optimistic forecasts in parallel, of course colourful and acidic bubbles show up as no warming up has been accomplished before such decision making by which economic engine burns out quickly. What if pre-heating is going to be done through fixed income securities?
Sometimes it is not about the right choice of a scenario, but the right flow of scenarios. A scenario lives in a confined space but not so strictly. It’s side effects would strengthens or weakens other scenarios and if reordered then the impacts will be adjusted accordingly.
Scenario modelling, machine learning and platforms are just some of the ingredients of a soup which will be served in investment industry in coming years. The tastes should be aligned accordingly, business models be shifted and traditional methods blurred.
Intervention if not cooked properly, detoxification costs rose up.
Great Tips from CFA Institute
Stock Price and Intristic value are 2 different price tags. Need to draw a very clear line what kind of forecast. I do agree with the author that we shouldn’t waste time too much time to determine the future price. Ultimately the stock price is what we pay to own the business. Believe the business fundamental is solid with profit. And the hidden gem will be shine one day.