In November 2022, CNBC asked 761 people who owned at least $1 million (£788,490) in investment assets how equities would perform during the next year.
56% said US equities would lose at least 10%. Over the previous half-century, such stocks had declined by that much only six times. Either most of the survey’s participants were unusually insightful (able to predict an event with a 12% probability before it occurred) or they were blithering idiots.
Hmmm. About that. What's more, the last time that the poll's respondents were so bearish was in 2008, which gives the millionaires a perfect record. Whenever they heartily dislike stocks, US equities promptly gain 26%.
Problem #1: Recency Bias
Admittedly, the survey was unscientific. How CNBC selected its 761 participants from among the several million possibilities is unclear, but given the questions were administered online, the result is unlikely to pass academic muster. Besides, most people realise they cannot predict equity returns. Ask the question and they may respond. However, that doesn't mean they truly believe their answers.
Nevertheless, the exercise was revealing. As with all endeavours, investment predictions are strongly affected by recency bias. After a well-publicised plane crash, airline travellers become warier, with their fears gradually dissipating along with the memory of the accident.
Likweise, consumers are fonder of large SUVs when gas prices are depressed than when they are spiking. And when asked about the stock market's prospects, retail investors are gloomiest after bear markets.
Problem #2: Group Think
For the most part, professionals avoid such errors. Almost all attended business schools, where they were instructed to avoid recency bias.
Also, given the difficulty of making such forecasts, discretion quickly becomes the better part of valour. Their predictions are therefore much steadier than the millionaires' outlooks. Entering 2023, the median projection among 20 Wall Street firms was that the total return for the S&P 500 would be 4.5% – slightly more conservative than usual, but much above what retail investors guessed.
Where professionals run into trouble is with economic forecasts. They are also expected to provide those, and with that task they do not duck the challenge. When asked in October 2022 about the following year's real gross domestic product growth, Wall Street strategists gave a median answer of a puny 0.20%. Only 11 of the 78 respondents predicted a growth rate that equalled or exceeded the 50-year annualised average of 2.6%. That is pretty much what 2023 will record.
Consequently, those who used economic predictions to guide their investments almost certainly suffered for that decision. Typically, the arrival of a recession is accompanied by bond market strength and stock market weakness, albeit with relatively good showings from recession-resistant equities: consumer staples, healthcare, and utilities. In 2023, the opposite occurred. Long bonds struggled to break even, while equities soared. Conspicuously absent from the stock market rally, however, were businesses from those defensive sectors.
To some extent, the economists' fears were justified. An inverted yield curve caused by rising short-term interest rates, as was the case entering 2023, usually presages a recession. But professional economists are paid to anticipate the exceptions.
That so few did owes to the same reason that they missed 2021's inflationary spike. Collectively, they had their eyes on what others were saying. Their analyses were not entirely independent because of group think.
Problem #3: Wishful Thinking
A long-standing joke of my former boss, Don Phillips, is that portfolio managers inevitably comment that the previous year was dominated by a single simple trend. You will now hear that making money in 2023 merely required owning the "Magnificent Seven". Whereas profiting in 2022 meant avoiding both stocks and bonds, because the Federal Reserve was stifling each marketplace by increasing interest rates. Buying growth stocks sufficed in 2021. And so forth.
Thus, Bank of America's investment strategists currently claim 2024 will be a "stock picker's paradise." Meanwhile, BlackRock's chief investment officer of global fundamental equities (the company’s active-management group) says 2024 is shaping up to be a "bonanza" for "stock pickers," while Leon Cooperman states that we are entering a "stock picker’s market." Toronto's Dennis Mitchell claims the same for the Canadian marketplace.
No doubt there is actual analysis intermixed with the wishful thinking, but don’t overlook the powerful influence of the latter. It is for that reason I routinely discount forecasts of economic booms from growth-stock managers and economic busts from bond-fund leaders (case in point: Bill Gross' downbeat prognosis of a slow-growth "new normal" that would allegedly depress equity returns, made just as stocks entered a huge bull market), along with complaints about overpriced stock markets from those who run value funds. In the words of Paul Simon: "a man hears what he wants to hear and disregards the rest."
Why Should I Even Bother With Forecasts, Then?
It is at this point where I might be expected to wag my electronic finger and counsel investors to ignore forecasts. That I will not do.
For one, the admonition would be hypocritical, as I partake too. For another, if consumed appropriately, investment predictions can be quite useful. The key is to follow their arguments rather than their advice. Understanding the logic behind the prophecy is an excellent way of learning more about both investments and the general economy.
When I studied for my MBA, I skipped the macroeconomics requirement, although I had never taken an economics course (such are English majors). No worries. After reading several hundred market forecasts, I had thoroughly learned the material. Along the way, I had also absorbed the initial lesson of the university's investments class: the difficulty of outguessing efficient markets. How right that was.
John Rekenthaler is vice president, research, at Morningstar. To get in touch with him, contact john.rekenthaler@morningstar.com
