Editor’s Note: The following is a guest column by Zachary Karabell, Head of Global Strategy at Envestnet.
T’is the season to be forecasting. At least that’s the case for Wall Street, which each year around this time sees an efflorescence of predictions for the year ahead. It has reached a point where every investment bank, research shop, and asset manager worth its proverbial salt issues a set of prognostications about what lies ahead. Those then act as media catnip, as the relentless maw of the cable, 24/7 and web world pounce on those oracular statements and add yet another layer to the predictive pie.
The problem, of course, is that all of these predictions are futile. They are futile because of the expectation that you can ever reliably predict the specific movement of markets. Year-end targets for the S&P 500 (^GSPC), for bond yields and prices, and for the GDP growth of nations large and small, are all only so much guesswork, and any look at the predictions of years past demonstrates that.
There’s another issue as well: as entertainment, the forecasting game is all fine and well. But it is not depicted as a game, nor do participants act as though they are playing. Instead, the noise of predictions becomes a distraction from the hard job of assessing how to invest, what to spend, and how to gauge risk.
It’s not that you can’t have strong views about what lies ahead. In fact, you should. But analyzing the world today and assessing likely outcomes for the year ahead is not the same as saying that you have a target of 2000 for the S&P 500 come December 31 of 2014.
Take what was being said a year ago. The average estimated return for U.S. stocks as predicted by Wall Street forecasters in December 2012 was 7% for all of 2014. That was off by such a wide degree as to by almost useless. The S&P 500 alone – barring a plunge over the final weeks of December – is up in excess of 30%. Even the most bullish forecast saw the S&P 500 up only 14%, which is still well short of the actual mark.
The looming concern for many forecasters was the potential for a U.S. government shutdown and inability to come up with a budget deal. As we know, those concerns proved entirely well founded. The government did shut down in October over the debt ceiling and the budget, and no agreement was reached. Yet stocks rallied nonetheless. Others foresaw and earnings slowdown that would presage equity weakness. Earnings were indeed unspectacular, with final tallies looking to be about 5-6%, yet stocks still soared.
The same story could be told for every year. And it’s not just equity or bond prices. It’s economic growth as measured by GDP, inflation, unemployment rates, and just about any statistic you can imagine. If there’s a number, there is a contest to see who can predict its arc over the coming twelve months. A year later, the “winners” are lauded. The Wall Street Journal annually hails the economic forecaster who came closest to calling the numbers correctly. The winner for 2012, economist Arun Raha at power company Eaton, was closest in his predictions for the unemployment rate and overall GDP growth. His forecast for 2013 was for an unemployment rate of 7.8% at year-end. It is now 7.0%.
The point is not that economists such as Raha are wrong more than they are right. It is that the entire game of numbers guessing is misguided and does little to help investors, the general public, or the national conversation about economic policies and spending. There is simply no way to know with anything resembling certainty how stocks will behave or how supply and demand will precisely play out in things such as corporate earnings or national economic growth. There is no way to craft models that factor in issues such as October’s government shutdown, or a hurricane. There is no way to calculate with any precision the ramifications of the Fed’s $85 billion a month of bond buying, and no way to calculate the precise effect on stock and bond prices that the tapering of such purchases will have.
Even more problematic, the focus on forecasting a number diminishes the emphasis on what we can actually do and what some people do exceeding well and others do rather poorly: analyzing the world as it is and crafting concrete scenarios along with actual investment plans. Concrete scenarios do not entail a specific target for GDP or stocks, but rather directionality over time: will China continue to expand and will its growth shift from state spending on infrastructure to consumer-driven demand? Will the United States see wage increases among the now-stagnant middle class? Can corporate profits remain high relative to GDP? Is the excess liquidity in the world likely to move into stocks, bonds, real estate, commodities, all of the above, or some?
These are large-scale issues that can be assessed and arguments can be made. You can make an argument for why China can continue to grow and shift its economic mix, as well as an argument for why U.S. equities could see continued strength regardless of whether the Fed and other central banks withdraw some liquidity from the marketplace. That is not the same as calling for a year-end number, nor does it preclude the real and ever present possibility that neither stock nor bond markets reliably reflect the movement of economic statistics. U.S. GDP could be strong and stocks weak, and vice versa. That has happened in the past, and should never be discounted in the future.
Over the course of several years, some people are clearly more right than wrong in their overall view of the world and its many specifics. These views can be assessed and the acumen of those purveying them can be as well. But simply pegging the right number over the course of twelve months tells you little. Holding up those who “get it right” would be like holding up a lottery winner and then trying to glean insights into their methodology of picking “1, 7, 25, 96, 8.”
The forecasting game distracts from the important and vital questions that all investors need correct answers to: what is the level of growth across industries, nations and financial markets? What are the risks and what is the probability? How does one deploy capital relative to needs and expectations given best assessments of the questions above? Those are more nuanced discussions and do not hinge on whether the S&P 500 goes up or down in any one year. Those are the discussions we should focus on, rather than the noisy, distracting and ultimately irrelevant horse race of who guessed what right and who did not. There can be some innocent fun in that race, but only if it does not serve as the basis of consequential decisions about how to navigate the world.
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