 "Wall Street’s annual stock forecasts: Bullish, and often wrong")
Don’t expect Wall Street investment houses to predict a stock market decline in 2017. That’s just not what they usually do.
Instead, they engage in an annual ritual that is underway right now: Every December as the holidays approach, Wall Street gurus examine the stock market, and nearly all declare that stocks will rise in the forthcoming calendar year.
The forecasts are still coming in for 2017, but preliminary tallies suggest that - no surprise - strategists are bullish, probably mildly so. Through last year, since 2000, the consensus has always been bullish, holding that the market would rise, on average, about 9.5 per cent a year, according to calculations by Bespoke Investment Group. In reality, it rose only 3.9 per cent a year, on average, in that period.
So the cheery predictions have often been wrong. Does it really matter? After all, the stock market actually rises most of the time.
Bullish predictions encourage investors to pour fresh money into the markets, helping asset management companies to enjoy rising profits. Even if returns don’t match the expectations set by forecasters, memories are short and money is being made.
But here’s the rub: The stock market sometimes falls, and from time to time, it absolutely tanks. Since the start of 2000, the Standard & Poor’s 500-stock index has ended in negative territory in five calendar years (2000, 2001, 2002, 2008 and 2015) and has been virtually flat once (in 2011). But while a handful of individual forecasters have, from time to time, predicted mildly negative years for stocks, the Wall Street consensus in every single year since 2000 has predicted a rising market. Consider the calamity of 2008. If you had money in stocks that year, you would probably remember. The S&P 500 fell 38.5 per cent in the course of those 12 months. It would have been very useful to have received advance warning that stocks were about to plummet, but the Wall Street consensus did not ring out an alarm. On the contrary, the forecast for 2008 was unusually bullish, calling for a rise of 11.1 per cent. Wall Street missed the mark by 49 percentage points that year.
How bad is the industry’s track record in making predictions? I had assumed that the annual forecasts were essentially worthless - no better than flipping a coin. But Salil Mehta, an independent statistician who has blogged about the topic, tells me I’ve been too kind. The forecasters, as a group, are much worse than that. “It’s not easy to be as bad as they are,” he said in an interview. “They are much worse than random chance alone would predict.” (Mehta was formerly the director of research and analytics for the United States Treasury’s Troubled Asset Relief Program and for the federal Pension Benefit Guaranty Corporation.)
After examining forecasts by major investment houses going back to 1998, Mr. Mehta found that 8 per cent of individual analyst predictions called for a small market decline in subsequent years. But those predictions of decline were worse than random: In the years when the market did fall, 9 per cent of forecasts — never enough to counter the bullish consensus — predicted that it would happen, essentially the same as in a year in which the market rose.
Yet, as Mehta found, the typical negative individual forecast only called for a 5 per cent decline, so the size of forecast errors, like the 49-percentage-point error of 2008, was larger than would be expected from mere chance. On a statistical basis, the forecasters were “actively adding negative value” — essentially destroying value by issuing spurious numbers.
If I were to simply program my computer to predict a market increase of, say 5 per cent each calendar year, without fail, Mehta said, my forecasts would be better than the consensus version —which is to say, they would be lacking in value. The forecasts are worse than that.
Oddly, 2016 is likely to look like a reasonably good year for the consensus forecasts, which last December called for the S&P 500 to end 2016 a little above 2200. That is where the market is hovering now. But even this year is no time for gloating: Early in 2016, the market declined sharply and forecasters shifted their predictions lower. Then they adjusted upward after the market rebounded. The consensus forecast this year looks good only if you rely on the December version and discard the other two.
© 2016 The New York Times News Service
