Annual investment forecasts are junk, and everyday investors are worse off for paying attention. Yet each December, without fail, Wall Street analysts become short-term prognosticators, providing detailed market predictions for the upcoming year.
Granted, these analysts are typically quite thoughtful and intelligent. They have fancy MBAs, PhDs, and CFA charters. They have expensive Bloomberg terminals providing millions of market datapoints, computer screens displaying complex charts and neon squiggly line analytics, and proprietary forecasting models with thousands of economic variable inputs.
But none of this changes the way that today's prices becomes tomorrow's prices, or the prices at the end of 2023.
No one can systematically predict the unpredictable.
Like nearly every other documented year, 2022 stock analyst forecasts turned out to be abysmal, with the average prediction having a 30%+ deviation from what actually occurred. Too bullish this year. Too bearish last year (and the two before that).
It all stinks, with an occasional blip of luck where realized returns are similar to the predicted returns. Why can't these professionals do better? The answer isn't that they should try harder, but rather that they should simply stop trying.
Investor outcomes are a combination of two things: expected returns and unexpected returns.
And no one can forecast unexpected returns with precision.
Unexpected returns are how prices react to random, unforeseen occurrences in the future. Contrast that to expected returns, which are derived from characteristics of the asset itself.
Consider stocks, which represent ownership in companies. They never mature or expire. You can own them forever, but they don't promise you anything. The long-term average return of the S&P 500, a diversified portfolio of large U.S. stocks, is about 10% per year. But the volatility is mind-numbing — you hardly ever get close to a 10% return in any year:
Does 10% per year seem reasonable for delaying consumption of your money, instead investing it, and withstanding all this volatility? Sure, seems reasonable enough.
10% has been the long-term average of owning stock in major companies that drive the U.S. economy. But the 10% itself is quite elusive in any specific year. Why?
Unexpected returns! Events like wars, financial crises, pandemics, and unforeseen inflation spikes to the downside. Life-changing technological innovation, robust economic recoveries and vast expansions to the upside. Over long periods they generally net each other out, but over short periods, unexpected returns drive almost everything.
Short-term stock predictions are just guesses, potentially educated guesses with regards to economic models, but uneducated in that they overlook how short-term returns get realized...which is predominantly by unexpected returns. One year is a very short time period.
Interestingly enough, bonds are quite different. They mature, and return your initial investment back to you when they do. They also pay stated amounts (coupons) back to you throughout their life, and on predefined dates. These characteristics give us more information about expected returns than we have for stocks (and it's also why bonds have relatively lower expected returns than stocks...they provide you more clarity around your likely outcome, which might be nice but isn't going to be free).
In fact, if you buy a bond and hold it to maturity, you can almost know your exact return at the time of purchase! So for traditional bonds, especially those with shorter maturities, we know so much about expected returns that unexpected returns don't matter that much. Even over short periods. Compared to stocks, there's not much that can cause bond's actual returns to frequently deviate from their expected returns. Some years it happens, but it's rare.
The balance between how much of an asset's return is driven by its expected return vs. unexpected return tells us whether investors can make reasonable predictions over the short-term.
Bonds — sure.
Stocks — no way.
If you went to see family this holiday season, you may have set expectations. Live in the same town? Give them an exact time to expect you, and with a high probability of reality matching expectation. But if you need to drive across the country to get there, you can't. Predictions need to widen out (or potentially not exist at all) with more potential unexpected occurrences.
Wall Street analysts, and maybe your friends or neighbors (and *gasp* — some financial advisors) with annual stock predictions aren't necessarily ill-intentioned, but they vastly underestimate unexpected events.
My own 2023 predictions:
U.S. Stocks: UNWILLING TO FORECAST
Int'l Stocks: UNWILLING TO FORECAST
Emerging Mkts Stocks: UNWILLING TO FORECAST Growth Stocks: UNWILLING TO FORECAST Value Stocks: UNWILLING TO FORECAST Small Cap Stocks: UNWILLING TO FORECAST Large Cap Stocks: UNWILLING TO FORECAST ST Inv. Grade Bonds: Between 2% and 5% LT Inv. Grade Bonds: Between 1% and 9% Venture Capital: UNWILLING TO FORECAST
Private Equity: UNWILLING TO FORECAST
Real Estate: UNWILLING TO FORECAST
Commodities: UNWILLING TO FORECAST
1 Year Treasury Bond: 4.722% Bitcoin: UNWILLING TO FORECAST Other crypto: UNWILLING TO FORECAST
What did you expect?