The futility of trying to time the market and how six Wall St institutions got it horribly wrong

Patrick Fogarty

Here we go again. Another year begins and, like clockwork, out come the soothsayers, the prognosticators, the suit-cladded oracles with erudite predictions for the year ahead.

If you follow the markets and regularly consume investment journalism, you will no doubt be familiar with the seasonal, start-ofthe-year prediction cycle. All the major players get in on the action, outlining well-constructed narratives describing what will “drive markets going forward” and setting expectations for where they believe markets will land by the end of the coming year.

The predictions are convincing, filled with reassuringly sophisticated investment language and well-crafted conclusions based on expert opinion.

It would, on the surface, seem foolish to ignore what these experts have to say. Surely with their significant resources, the advanced systems at their disposal and their unrivalled access to company information they must have an edge when it comes to predicting the direction of stock markets. Right?

On 1 December 2021, Sergei Klebnikov, markets staff writer for Forbes, posted an article titled Here’s What Wall Street’s Biggest Banks Predict For Stocks In 2022 – And What To Watch For. It encapsulates the collective mood on Wall Street, summarising the 2022 outlook for the S&P 500 (the US stock market) across eight major financial institutions.

It leads with an optimistic tone, that “the majority of Wall Street firms predict the stock market will continue to rally next year, albeit modestly, thanks to strong corporate earnings, solid economic growth and easing supply chain issues.” From here the predictions become more granular, with each institution providing a unique take on the investment landscape and a price prediction for the S&P 500 at year’s end. So, how did they do?

Let’s start with arguably the most famous, or perhaps infamous, institution in the list, Goldman Sachs. According to Klebnikov, Goldman predicted the value of the S&P 500 would rise in 2022, estimating a nearly 10% gain. A cautious note to investors stated “decelerating economic growth, a tightening Fed and rising real yields suggest investors should expect modestly below-average returns next year”. However, despite these headwinds, Goldman remained confident “the equity bull market will continue”.

This optimistic tone was consistent with JP Morgan, where bullish analysts set a price target for the market amounting to an approximate 8% gain for the index, citing robust earnings growth and a recovering labour market as key drivers.

Striking a more prescient tone, the bank tempered its outlook, noting a “hawkish shift in central bank policy” as a potential concern, especially if supply-chain issues and labour shortages continue.

Bullish sentiment also made its way into the halls of UBS, where analysts predicted a nearly 5% gain for the S&P 500. The bank predicted stocks were “likely to have a pullback at some point”, but felt confident that strong corporate earnings and the eventual decline of covid cases would ultimately push the market higher.

In total, eight major Wall Street institutions were profiled. Of these, six incorrectly predicted a positive trajectory for the year ahead, with end-of-year price predictions ranging from 4,850, to 5,300 at the

Continued on page 09

Continued from page 08 top end (the starting point being 4,766 at year-end 2021). For the latter, this represents a 1,461-point differential, or a roughly 28% gap, between the price they predicted and where the index ultimately landed by year-end 2022 (3,839).

Two of the profiled institutions, Bank of America and Morgan Stanley, did manage to correctly pick the downward direction of the index. However, this would have offered little consolation to investors looking for guidance as their predictions, while correct in terms of trajectory, were still out by approximately 17% and 13% respectively.

Real-time response

So, what is the ultimate point here? While I have always enjoyed pointing out the inadequacies of those who purport to be able to predict the future of stock prices and charge obscene fees for the pleasure, my intention in this piece is to help people arrive at an ‘aha’ moment I had early in my career.

The American economist Eugene Fama, widely recognised as the “father of modern finance”, won a Nobel Prize for his work on market efficiency, an area of research that looks at how quickly a company’s stock price incorporates information. As it turns out, for publicly traded companies like those in the S&P 500, the process is very quick indeed.

I have no doubt the aforementioned analysts, who worked tirelessly to arrive are their conclusions, are intelligent, insightful and highly valuable employees to their respective institutions. However, I do not believe for a second that they can predict the future. No one can.

If we are to agree with Fama, as I do, that the market is an extremely powerful machine that ceaselessly processes information in real time, efficiently adjusting prices as new information becomes available, then it is logical to conclude that the future direction of stock prices will be determined by future unknown events.

In February 2022, Russia invaded Ukraine, resulting in unprecedented sanctions, soaring energy prices and all manner of implications for global trade and inflation. Queen Elizabth died in September, shortly before Liz Truss, the shortest-serving English Prime Minister of all time, unveiled monetary policies that would drive the British pound to an all-time low against the US dollar. The Bank of England was forced to support the bond market for fear of a broader economic collapse, the ‘cryptosphere’ saw a near-collapse with the demise of heavyweights Terra-Luna and FTX, a European fuel crisis loomed, China began easing its zero-covid policy, the US Fed furiously hiked rates, political unrest hit boiling point in Iran, climate change indicators intensified and, perhaps most importantly, Will Smith slapped Chris Rock in the face at the Academy Awards.

Suffice to say the world is unpredictable, full of unforeseen events that shape economic returns. Attempting to use the information available at any point in time as a basis for predicting future prices is to discount the unknown variables that will invariably shape the world. Knowing what will happen next, typically, has very little to do with creating a positive investment experience.

Investing in the S&P 500 has, over the long-term, generated remarkable returns for investors, irrespective of their predictive prowess. Simply holding the index over the last 30 years would have delivered you a return just shy of 10% per annum, despite some considerable intra-year volatility.

Pointless exercise

The essential point here is that spending time attempting to decipher the vagaries of the markets is rarely a useful enterprise. Those who do, often get distracted by spurious short-term market events and make rash decisions that can destroy value.

The futility of endlessly chasing market-beating returns is a topic supported by endless academic studies, nonetheless the number of investors in New Zealand who still believe the role of their adviser is to help them predict the future is still extremely high.

Quality advice should always start with a thorough analysis of your personal situation and an assessment of your unique objectives. It is from this foundation that a tailored investment strategy can be implemented, one that prioritises what is important to you and provides confidence that your desired outcomes are realistic and achievable.

How you should invest the proceeds of a financial windfall, how much you can afford to spend in retirement, the sort of legacy you will leave for the next generation: these are the sorts of things a competent adviser can help you grapple with rather than trying to predict where the S&P 500 will be in 12 months’ time. ■ Patrick Fogarty is a principal and financial adviser at Rutherford Rede ■