Research Director Monthly Comment- December 2017

The Market Prediction Game

 It is that time of year and Barron’s magazine this week ran its annual “market forecast” issue in which the Wall Street brain trust (market strategists) makes their predictions about stock and bond returns for the coming year. Earlier in my career I used to consider this a very important and prescient article but over the years have come to discern that the accuracy of Barron’s group of strategist predictions are usually about in line with the broad averages of market predictions: about 50-50; or in other words, about the equivalent probability of a coin toss.

 

Given where we’ve been over the past nine years, the article seemed more like entertainment. This is not to put these folks down. They are all bright, highly credentialed, hard working, and have a high level of knowledge in their field. They are making reasoned educated guesses and some of those will be correct (or close). But the nature of the forecasting game is the markets have an uncanny way of fooling the great majority of investors (or investor “consensus”). And just because you are dying to know, here are the fearless consensus 2018 forecasts for several key market variables:

                Stock market total return: +7%

                Yield on 10-year U.S. Treasury on December 31, 2018: 2.8% (current: 2.35%)

                Corporate profit growth: +10%

                U.S. real GDP: 2.6%

Our take on all this? We generally agree that fundamentals for stocks remain positive for a number of reasons. There do not appear to be excesses in the credit or bond markets that would precipitate a major market adjustment. While aggregate stock valuation is elevated at about 18x forward earnings, we do not believe it is at such an extreme level that it would prevent the market from rising further. What are some of the risks? 1) that inflation is higher than expected; and 2) market sentiment is quite bullish now, which can be viewed as a negative “contrary” indicator.

 

Where do we put our energy? So what’s the point about market prognostications? It is the fact that over long-periods of time, it has been shown that both short-term market forecasting and market timing activity associated with this forecasting is difficult if not impossible and the best place for us to place our energy in managing our client’s capital is a) managing risk, b) setting appropriate portfolio allocations, and c) working diligently to select the best investments to achieve client financial plan objectives. It has been shown that diversified portfolios can and should deliver higher risk-adjusted returns than all-equity portfolios over time because they are inherently less volatile and, as a result, returns are more stable. This is extremely important for both financial planning and risk management and especially important for older clients who are not in a position to suffer a serious asset drawdown.

 

Robert Toomey, CFA/CFP

Vice President, Research

December 14, 2017