Monday, November 24, 2014
My 2015 Market Forecast: All Forecasts Will be Wrong
The investment media is a rare industry in which professionals are rewarded for making bold projections but never punished for being wrong. The more outlandish a pundit’s forecast the more attention it receives. Yet, surprisingly little consideration is given to how accurate the prediction turns out to be.
At the beginning of 2014, there were some widely-accepted expectations regarding the investment environment. Let’s review those predictions and analyze how precise they really were.
In a study conducted by Bloomberg at the beginning of the year, all 72 economists surveyed predicted higher interest rates and falling bonds prices in 2014. Consequently, investors were questioning whether they should reduce or eliminate the bond portion of their portfolios until the rate increase occurred.
So have we experienced this rise in interest rates? On January 1st, 2014, the yield on the 10-year Treasury note was 3 percent. On November 13th, the yield on the same note was 2.35 percent. That's right -- interest rates actually decreased significantly during the year. As a result, intermediate U.S. government bonds (ticker - IEF) produced a return of 7.38% during the year. Not bad for the conservative portion of your portfolio!
The most widely promoted fear among forecasters was that the phasing out of the Federal Reserve’s quantitative easing (QE) program would diminish stock returns. Prognosticators worried that the Fed would lower the amount of loans the government would buy from commercial banks, thus reducing the amount of money available for new businesses to borrow leading to less innovation and the creation of fewer jobs.
So was the reduction of quantitative easing a legitimate fear? In fact, this possibility came to fruition. In December of 2013, the Federal Reserve was buying $85 billion of financial assets from commercial banks each month. The Fed reduced this amount during every meeting it held this year, finally eliminating the action completely in October.
However, the elimination of Quantitative Easing did not have a negative impact on the unemployment rate, which declined from 6.7% in January to 5.8% in October. Further, the S&P 500 has gained 12.31% year-to-date (as of 11/13/14). Clearly, fading out the Quantitative Easing program didn’t have the negative impact on stocks that many pundits expected.
Another widely held viewpoint at the beginning of the year was that 2014 was likely to be more volatile than anything experienced in 2012 or 2013. There was talk about valuations and P/E ratios being too high, concern about the war in Ukraine (ISIS wasn’t even in the headlines yet), and endless noise about unfavorable weather patterns impacting the market.
So has 2014 been a wild ride? Since 1929, the S&P 500 has experienced either a rise or a decline of more than 1% during 23% of trading days. In 2014, the S&P 500 moved more than 1% only 15% of the time. Less movement equates to less volatility, so again forecasters were inaccurate.
Bloomberg News recently published a story titled Predictors of ’29 Crash See 65% Chance of 2015 Recession, in which the grandson of a prognosticator who luckily forecasted the Great Depression is still getting attention for a guess his grandfather made 85 years ago. If giving credence to forecasters isn’t ridiculous enough, suggesting there is a gene for forecasting is insane!
The article doesn’t mention that the same grandson made similar headlines with the same forecast in both 2010 and 2012; of course, those predictions did not work out so well. You will start hearing many 2015 projections soon, so pay no heed.
Ignore the Pundits
The most significant lesson inherent in these numbers is that market expectations are essentially useless. Despite their abysmal track record, the news media loves forecasters because they capture attention and fill space. Unfortunately, pundits making projections are rarely held to their inaccurate forecasts and are allowed to continue making a living showing they have no greater knowledge than the average investor.
Of course, this is not to say that interest rates will never rise, that bond values will never decline, and that the market won't return to the roller coaster it is. In fact, all those things are certain to happen. Unfortunately, anyone who contends to know “when” likely doesn't actually know anymore than you or me. For this reason, having and sticking to a diversified investment strategy that coincides with a detailed financial plan is the most probable path to financial success.