At the end of every year, I enjoy looking back at all the predictions that the so-called experts had at the beginning of the year. Mostly, these predictions come from people who don’t really have much of a clue; they just have an agenda.
I’ve noticed that all the really smart, rich, and powerful people in the financial world say the same thing. Nobody has any idea what the future holds, unless you want to count educated guesses.
The real story is that annual predictions are rarely correct.
The year 2014 started off with a healthy dose of volatility, thanks to falling oil prices and renewed fears in Europe, which are creating wonderful opportunities for buyers.
Now, more than ever, investors are anxious to hear from market pundits and investment managers on how they think equities will perform in 2015.
This question is certainly warranted given the events that have transpired over the last decade, and investors want to know that they are with a manager who is good at predicting annual returns because he/she seemingly has a “feel for the market.”
Unfortunately, annual forecasts are almost always wrong, and the very few who will get it right will be nothing more than lucky. Predicting annual returns from an asset class as emotionally sensitive as equities, on a consistent basis, is virtually impossible.
Fear and greed are incredibly powerful and unpredictable forces that create dislocations in equity prices that often take months to normalize, which wreak havoc on short-term forecasts.
Think back to some of the events that rocked equity markets in 2014; it’s implausible to assume that any investor would have accurately predicted that oil would drop over 45 percent in six months, Russia’s economy would come under tremendous pressure after invading the Ukraine, and Ebola would make it to the US.
Each of these events jolted equities, but they now appear to be either immaterial (Ebola) or actually beneficial to our economy (cheap oil).
However, time was needed for the market to shake out the emotion and return to operating on fundamentals.
Predictions are not completely useless; rather, it’s important to know how to best use these forecasts as a manager and as an investor. The process of forecasting an annual return forces a manager to think about all of the complexities in economies and financial markets; growth over a one-year period is extremely difficult to do with any level of statistical accuracy.
This conclusion comes as no surprise considering the sheer number of variables that can impact Gross Domestic Product (GPD) on such a short-term basis. For example; who could have possibly predicted that a polar vortex was going to cripple consumer spending last year by preventing most of the country from leaving their homes in the dead of winter?
Note: US GDP is nowhere near as volatile as the S&P 500; so imagine how hard it must be to estimate a number that is as emotionally sensitive as an annual equity index return if consensus can’t even get GDP right!
The process of forecasting an annual return forces a manager to think about all of the complexities in economies and financial markets, which creates a blueprint that can be then used to isolate the factors that currently matter the most.
Investors are best served by using a manager’s forecast for more than just a measure of perceived skill. Comparing a forecast to the actual return at year end will give very little insight into a manager’s aptitude because you must dig deeper to eliminate the possibility of luck.
Rather, ask how he/she derived the forecast, and how he/she plans to act throughout the year if their original thesis turns on them. Only then will you get true value from their predictions for the coming months.
The bottom line is that annual forecasts are rarely accurate, but they are still a critical component to investing and provide tremendous value to both investors and managers alike.
Once you concede the fact that while nobody knows what the future holds for sure, a true professional money management program at least gives us the best chance at guessing and then correcting investment strategies as the year proceeds.
So in 2015; look for the right financial professions to help you with the educated guessing and re-guessing for this year.