Written By: Darren Morris – Corporate Finance
Many investors, individual as well as institutional, rely on market experts and forecasters when making investment decisions. But are the predictions of Wall Street gurus always trustworthy? Recently Nir Kaissar, a Bloomberg Gadfly columnist, analysed a set of predictions by market forecasters over a 17-year period from 1999 through November 2016. He came to a sad conclusion: the forecasts made by specialists were the least useful when they mattered the most.
Indeed, he found, for instance, that:
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there was a reasonably high correlation (0.75) between the average forecast and the year-end price of the S&P 500 Index for the given year,
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but these predictions were surprisingly unreliable during major shifts in the market.
Thus, Kaissar found that the strategists overestimated the S&P 500’s year-end price by 26.2 percent on average during the three recession years 2000 through 2002. Forecasters also underestimated the index’s level by 10.6 percent for the initial recovery year 2003. Errors in forecasts were higher for the last 2008 crisis: Kaissar found that for the 2008 crisis, strategists overestimated the S&P 500’s year-end level by a whopping 64.3 percent! They also underestimated the index by 10.9 percent for the first half of 2009.
Forecasters are optimistic when markets are dull and pessimistic when markets are up.
It was before the last major crisis that the gurus’ lack of prescience reached a peak. No surprise in the fact that the best professionals in the business have difficulty consistently beating the market over the long-term. Markets are incorporating many collective behavior-like bandwagon effects; incorporating the collective judgements of many hundreds of thousand participants worldwide leads to amplification of movements. And if professional and institutional investors are including in their organizations sophisticated mathematical algorithms, powerful computer systems and high-frequency trading facilities, their decisions are coming from past or present observations.
One must recognise the certain impossibility of prediction based on the past history of the time series. Institutional investors’ decisions can also amplify movements that are just starting.
Experts are better forecasters of short-term rather than long-term evolutions.
A recent study titled “Evaluation and Ranking of Market Forecasters”, led by David H. Bailey, Jonathan M. Borwein, Amir Salehipour and Marcos López de Prado, examined the accuracy of predictions made by 68 forecasters (editors of specialized letters, managers, journalists, strategists). The authors proposed a methodology able to rank the accuracy of the forecasters by taking into account the number of predictions they made, but also the shorter or longer terms in which they made their predictions. They analysed the S&P 500 forecasts carried out between 1998 and 2005, covering the period from 2005 to 2012.
The predictions of the self-proclaimed Wall Street gurus proved unreliable in the long run.
Two-thirds of strategists’ correct predictions were for very short-term forecasts of US equities (less than one month). The longer the horizon (beyond three to nine months), the less reliable were their expectations. Only 14 percent of good forecasts had a duration of more than nine months.
Accuracy of forecasting is due to nothing else but randomness.
According to the study of Bailey, Borwein, Salehipour and de Prado, across all forecasts accuracy was around 48 percent. It challenges the concept of the existence of skill in forecasting the evolutions of the markets. It found that if the highest accuracy value of prediction was 78 percent, and only 6 percent of forecasters had accuracy values between 70 and 79 percent, the majority of forecasters (two-thirds) had accuracy levels below 50 percent.
The authors concluded: “In brief, our findings and results show that some forecasters have done very well, even more so than reflected in earlier studies, but the majority perform at levels not significantly different than chance, which makes it very difficult to tell if there is any skill present.”
Who are the best forecasters?
This part of the study is also very interesting; it shows that most of the best forecasters are professionals who work in small structures and shops. There are many technical and graphical analysts among the gurus of this classification. At the top of the ranking is John Buckingham, editor of the specialty letter “The Prudent Speculator”; followed by Jack Schannep, a technical analyst with “Dow Theory”; David Nassar from Dreman Value Management; and Bob Doll of Nuveen Asset Management.
Most media gurus are far from the best performers. And an astrologist is beating a Goldman Sachs strategist: Linda Schurman ranks 44th out of 68. Her company does not produce financial but “astrological-financial” forecasts! It believes that the stars have an influence on Wall Street cycles and has been issuing forecasts accordingly since 2004. Her forecasts were better than those of some 20 other forecasters, including Abby Joseph Cohen (57th), former Goldman Sachs strategist and now president of the Goldman Sachs’ Global Market Institute, and Jim Cramer, the financial journalist who makes recommendations on CNBC’s Mad Money program. Marc Faber, the Hong Kong-based financial advisor, is 51st. At the bottom of the ranking is Robert Prechter, the technical analyst who analyses markets through the Elliott Wave theory.
To conclude, the evolutions of stock markets are far from being predictable, and their mysteries have to be left to the investor’s own judgement.