Whiffing

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  By Guest Blogger Doug Rowat

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Forecasts come in many forms, but two types get the most media attention.

First are the shocking and dire forecasts, which provide great headline value for media outlets. Fear sells, don’t ya know:

The sky is falling!

Source: CNBC, Business Insider

These forecasts usually appear shortly after a major market or economic downturn when investors are already primed with anxiety thus giving the dire forecast maximum traction. But a clue that you can ignore them often lies in the forecaster’s modus operandi. David Tice, for instance, is a “long-time bear”. It’s of little value to investors to be an eternal pessimist when, of course, the majority of the time stocks perform well. Unsurprisingly, the above forecasts were wildly inaccurate as markets have advanced strongly since the articles were published. So much for their warnings. We’ve argued before against permabear forecasters (https://www.greaterfool.ca/2016/08/20/apocalypse-later/), so I won’t belabour the point, but simply put, it’s best to disregard them.

The other type of forecast that garners plenty of media attention is the cheerful consensus outlook, which is usually trotted out by the financial press at the beginning or midway point of the year. In its own way, the consensus forecast is just as faulty as the dire predictions. New York Times journalist Jeff Sommer highlights just how bad these consensus forecasts can be:

In December 2019, the median consensus on Wall Street was that the S&P 500 would rise 2.7 percent in the 2020 calendar year. At the moment, that target is too low: On Friday, the market was up almost 15 percent for the year [Sommer’s article is dated December 18, 2020—the S&P 500 actually ended the year up 18%]. That’s a forecasting error of more than 12 percentage points — much greater than the estimate of the market’s increase for the entire year.
How bad of a forecast is that? It’s as if you were told that it would snow 2.7 inches just before a blizzard dumped 15 inches on your town.

What’s worse is that the Wall Street consensus forecast then abruptly became extremely bearish. After February and March 2020 were in the books, Wall Street analysts recalibrated, calling at that point for an 11% DECLINE in markets for the year. Unfortunately, that consensus forecast basically coincided with massive Fed and government stimulus and, well, you know how 2020 ultimately turned out.

In fact, Sommer goes on to point out that the median Wall Street forecast from 2000 through 2020 missed its target by an average of 12.9 percentage points and not once did it call for a market decline when, in fact, six of those years actually saw markets drop.

So what to do?

Be skeptical of forecasts. Stay balanced. Stay invested. Remarkably, even if market predictions turn out to be entirely accurate (they almost certainly won’t be) and you time your entry points perfectly, outperformance still won’t necessarily be the result.

Dynamic Chief Investment Strategist Myles Zyblock compellingly argues this point. Zyblock examined four investor types across the S&P 500 market-timing spectrum. Over the long term, each investor type received a hypothetical $500 per month and could deploy this accumulating cash into the S&P 500 at any point that they felt was prudent. He nicknamed the investors: “Top Tick” Tommy, who always hit the major peaks (the worst timing); “Perfect” Penny, who always hit the major troughs (the best timing); “Steady” Eddie, who simply invested the 500 bucks regularly each month; and “Waiting” Winston, who never found a prudent entry point and never got invested. As you may have already guessed, Steady Eddie did the best, outperforming even Perfect Penny:

Hypothetical portfolio value based on market-timing investor type

Source: Dynamic; Based on the price variability and returns of the S&P 500 over 40 years. US 3-month T-Bill rate used for cash savings.

The accumulating cash drag of even someone as skilled as Perfect Penny explains the underperformance. As Zyblock concludes: “Even with extremely good predictions, we see that an investor can still lag behind one that is simply fully invested.”

Now, while market predictions should always be viewed with skepticism, this doesn’t mean that you shouldn’t still rebalance your portfolio regularly and (gently) tilt it towards regions, sectors or styles (value, growth, etc.) where the outlook is more favourable—supported, of course, by careful analysis.

The problem occurs when investors overreact to forecasts, trust them blindly and make dramatic portfolio changes or market-timing wagers as a result.

The best plan? Maintain a fully-invested balanced portfolio that you contribute to regularly and ignore anyone carrying a crystal ball.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.