28 January, 2018 Education

Monkeys and Market Predicitions

Monkeys and Market Predictions

No different than if a bunch of monkeys were trying to predict how the market would perform in 2018, some Wall Street strategists do get it correct. If enough try, some just get it right. This issheer luck. The inability though of strategists to predict the market has nothing to do with their intelligence, work ethic, or education. The challenge is that there are simply an infinite number of unknowns that can dramatically impact the market that cannot be predicted or foreseen.

Let’s consider just some of the recent evidence. The U.S. stock market, as measured by the S&P 500, is already up an incredible +7.4%. According to an article in the Wall Street Journal this week, the average of the 20 Wall Street strategist predicted the S&P 500 would end this year at 2850 or about a +6.5% gain for the year. We closed the week above 2872 obviously already exceeding the average forecast!

Source: Wall Street Journal 1/24/2018

Of course the market could go down between now and the end of the year and these strategists could be proven correct but some of these strategists aren’t willing to bet on that. Some are revising their estimates higher now. For example, the strategist at one of the country’s largest brokerage firms, Bank of America Merrill Lynch, had thought the S&P would close 2018 at 2800 but has now revised that to 3000 citing “sentiment may be most relevant for the S&P 500 over [the] next year.” This behavior further demonstrates that their forecasts are based on very little and instead extrapolate the recent past into the future. A monkey throwing a dart randomly at extrapolated numbers from the past could just as easily make such predictions. Instead, what I think most investors would find of most value would be the ability to forecast significant turning points when something very different from the recent past is expected in the future. That simply doesn’t happen. The most bearish strategist forecasts stocks would be flat in 2018.

2017 forecasts provide further evidence of these strategists’ inability to predict the market. The average of 16 of the most respected Wall Street strategists forecast a market gain of +4.0%. It was the most bearish forecast in 17 years! Instead the market surged more than +19%. The most bullish estimate was for a gain of +10.1%. The argument in their support is that nobody thought the market would rally like it did…nobody could have seen it coming. But that’s what they are supposed to do…see it coming!

The following graph shows the difference between the average forecast each year and the actual return. These strategist are consistently wrong and by vary wide margins!

The market is an uncertain place and big money is at stake for every investor. I think this drives investors’ desire for market forecasts in an effort to provide some comfort about what to expect. Unfortunately, the cold hard truth is that it is simply unpredictable in the short-term. On the other hand, it has proven very predictable long-term…it goes up! Furthermore, it is proven that the more diversified an investor’s portfolio, the more likely the outcome of a positive returns and certainly returns with less volatility.

The strategist will continue to provide forecasts that will sound well-researched and logical. In spite of how they sound and how well they are presented, it is simply random luck that it will be anywhere close to right…little different than a monkey throwing a dart at a dartboard. Choose to think and invest long-term.

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