Wall Street is again making irrelevant market forecasts

An annual ritual is underway at the major Wall Street investment houses: predicting exactly where the S&P 500 will finish the next calendar year.

This mission is impossible, but that hasn’t stopped teams of well-trained strategists at august brokerages and investment banks like Goldman Sachs, Bank of America and Morgan Stanley from focusing their analytical firepower on forecasting the future.

How wrong can these guesses be? Paul Hickey, a founder of Bespoke Investment Group, compared the yearly Wall Street predictions and actual market results starting with the forecast for December 31, 2000.

He found that the Wall Street consensus only ever predicted gains, every single year, of about 8.8 per cent on average.

Of course, there were big losses some years, as well as larger-than-expected rallies in others, so the variance between actual annual performance and the prediction was huge — an average gap of 14.2 percentage points.

Being wrong by that much means that these forecasts weren’t merely inaccurate. They were completely out of bounds.

The amazing thing, with a record like this, is that the strategists keep trying. I salute them for having the supreme self-confidence to stick with it.

I’m sure that I couldn’t predict the future of the stock market either, and I wouldn’t want to try. But if someone forced me to do it, my random guesses would include the possibility that in any given year, the stock market may fall. In fact, the S&P 500 declined in seven of the 25 calendar years in Hickey’s tally.

Yet in that period, the Wall Street consensus never predicted an annual stock market decline. When I’ve asked strategists about this privately, they have suggested that the reason for this constant optimism is that the investment houses that employ them favour a bullish outlook. Publicly, they tend to say that the positive predictions are simply the results of their “models” for the markets.

Whatever the reason, a credulous investor expecting gains every year would have been disappointed: In the 12 months of 2022, for example, the S&P 500 fell 19.4 per cent; in the recession year of 2008, it plummeted 38.5 per cent. True, those were years when developments like spiking inflation and the financial crisis rocked the markets in ways that were difficult to predict, but the forecasts for the past two years failed to reflect reality, too, in a different way.

After the terrible year of 2022, strategists became more cautious. For 2023, experts forecast a gain of 6.2 per cent, but the market rose 24.2 per cent. For the current calendar year, the consensus prediction was that the S&P 500 would rise only 3 per cent, yet by Friday, the stock market was already up about 24 per cent.

If you had lightened your stock market holdings in response to strategists’ predictions since the end of 2022, you would have missed out on a tremendous rally. That brings us to 2025. After failing to anticipate the soaring stock market, strategists are more optimistic than usual now, predicting a price gain of 9.6 per cent for the next calendar year. That number doesn’t include dividends, which would lift the total return of the S&P 500 above 11 per cent.

I’d be delighted with that result. But given all those previous misses, strategists’ belated optimism gives me no comfort and little information. I don’t have a crystal ball, but I see plenty of reasons for both optimism and pessimism about the markets.

The Federal Reserve trimmed interest rates again last week, by a quarter of a point, but it might slow down now. The economy has been strong, and some of the incoming Trump administration’s policies — like its intention to cut taxes and to lighten the regulatory burden for many companies — are likely to bolster the market.

Others, like much higher tariffs on a variety of countries, and mass deportations along with immigration restrictions, are far less popular among corporations and investors, and could disrupt the global economy. So, could political issues like the most recent conflict over funding the budget.

Important questions
Where the market, the economy and the country are heading are critically important questions. But I don’t have good answers. Instead, I’ve concluded that it would be wise to disregard all current rose-tinted claims to omniscience, and will continue to invest cautiously, based on history and long-term probabilities.

In a nutshell, this is my thinking: The stock market has risen over the long haul, but it has declined frequently and, sometimes, sharply. High-quality bonds have usually been safer. Trying to get in and out of the stock and bond markets with perfect timing is a fool’s game.

So, for serious investing, use cheap index funds to hold a diversified mix of stocks and bonds. Keep the money you will need in the next few years in safe places like insured bank accounts, money market funds and high-quality, short-term fixed-income securities. Plan on investing for decades if you can, and try to ride out the troubles that will inevitably afflict the markets from time to time.

It’s hard to avoid the annual stock market forecasts. So, enjoy them as the fortune-telling fantasies they have become, and keep them apart from your real investing life.