It’s that time of year when investors clamor for insight into where the stock market is headed. Before we turn to some of the brightest minds on Wall Street, let’s analyze their track record. The chart below compares the average annual forecast for the S&P 500 (blue bars) to the actual result at year end (purple bars). These estimates were compiled by averaging the individual forecasts from Market Strategists employed by some of the most prestigious institutions on Wall Street.
The only discernable trend is that their track record has been consistently abysmal. There were only three years when this very well-informed estimate came within 25% of the actual return (2005, 2010, and 2016).
These are not dumb people. They earned PhDs from top universities, work so many hours that they no longer remember their kids’ names, and are paid millions. They also have unlimited budgets, access to more data than they can consume, and an army of geniuses working for them to crunch the numbers. Yet they appear to be terrible at doing what they’ve been hired to do, which is forecasting annual returns.
How is this possible? Furthermore, if the professionals can’t get it right, where can investors go to get more reliable forecasts?
Getting Emotional
I obtained undergraduate degrees in electrical engineering and mathematics. The curricula were very structured and precise for a reason. As long as I accurately calculated all inputs, stuck to proven mathematical formulas, and obeyed the laws of science, prediction was possible.
However, financial markets do not operate on Newtonian physics. Think back to the events that impacted equity markets in 2021. I don’t recall seeing a single forecast predicting energy prices would rise over 50%. I also missed the report prophesizing that a group of amateurs was planning to use Reddit to orchestrate an attack on hedge funds so severe that it would drive more than one to the brink of failure.
Fear and greed are unpredictable forces that create dislocations in equity prices. These often take months to stabilize, which can wreak havoc on short-term estimates. Strategists may as well publish quarterly, monthly, or even daily forecasts because they are just as arbitrary as a single year.
The reality of their job is that they are being paid to do the impossible armed with an ineffective toolkit. Using process and logic to predict the mood of investors a year from now is like using antibiotics to cure a viral infection. What they really need is a crystal ball, and those are hard to come by.
But that’s not to say forecasting is a waste of time. Most business owners would agree that projecting sales and expenses at the beginning of each fiscal year is a valuable exercise. These estimates are almost always wrong, but doing so forces them to think about what could impact their business.
The same applies to the research these strategists publish. They might uncover investment themes and risks that a reader may not have considered. Incorporating the viewpoints of those who think differently or that have specialized expertise might help them avoid costly mistakes. That’s why I try to read as many of them as I can.
Simply put, it’s ok to follow market forecasts from smart people, but take them with a grain of salt. Forecasters are either lucky or wrong, and luck usually runs out.
The Bottom Line
John C. Bogle, the founder of Vanguard, published the instant classic, “The Little Book of Common Sense Investing” back in 2007. In it, he wrote:
“The stock market is a giant distraction to the business of investing.”
These words should be gospel to long-term investors because the way to achieve investment goals is to manage risk rather than take too much of it.
Within this context, if emotions dominate the short-term movements in stock prices, and emotions are unpredictable and fleeting, then so are their impact. If so, relying too heavily on annual forecasts could add unnecessary risk by shifting focus away from what can get you to your financial goals.
Revenue, earnings, cash flow, and other fundamentals drive long-term returns in financial markets. Therefore, rather than offer a forecast for the S&P 500 in 2022 (which would probably be wrong anyway), here are five themes that I believe will drive stock prices higher in 2022 and beyond:
- The early innings of rising interest rates are usually bullish for stocks.
- Inflation is a silent killer, but investors can invest to protect against it.
- Cash and a lot of the bond market should continue to lose money safely.
- Innovation today is staggering, and most of it is being born here in the U.S.
- Challenges facing investors today warrant a new playbook.
This list hasn’t changed much over the last six months because markets do not operate on calendars, where a New Year acts as a reset button. Instead, they are event-driven, and the events that fuel fundamentals develop over time and are rarely derailed from the emotional effect in the short term.
Hence, despite rising interest rates on the horizon, Russia invading Ukraine, Big Tech regulation, new variants, China invading Taiwan, Turkey’s currency crisis, midterm elections, and whatever else causes investors to temporarily panic in 2022, these themes should mostly remain intact.
The bottom line is that if Wall Street can’t get it right, then neither can you, me, nor anyone else. But since a year tells us little about the future of investment returns, remain focused on what will drive stocks over the long run instead.
Disclosures
This newsletter/commentary should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.