Fallacy of Forecasts

Many investors mistakenly believe that value can be added through market timing, or tactically moving in and out of market exposure based on near-term forecasts of expected market returns. If one could simply predict in advance how the market would perform each year, market-timing would make so much sense. But not even the experts can pull this off. So how is the average investor likely to do any better?

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Many investors mistakenly believe that value can be added through market timing, or tactically moving in and out of market exposure based on near-term forecasts of expected market returns. If one could simply predict in advance how the market would perform each year, market-timing would make so much sense. But not even the experts can pull this off. So how is the average investor likely to do any better?

In the illustration below, the blue bars depict the expected return from the S&P 500 for each calendar year, at the beginning of the year, as reflected by the consensus 12-month forward price target of Wall Street analysts and strategists. (Note the consensus always starts the year a positive number, perhaps the safest guess considering how the market delivers a positive return roughly 70% of the time).

The red dots indicate the actual return experienced by the market benchmark each year. The consensus is almost always wrong, and often dramatically so. Look for example at 2002 – analysts expected a return of +14% and the realized return was -22%. Or 2008, where expectations were for +16% and the actual return was -37%. In 2013 analysts expected only +2% and the market roared ahead +32%.

Clearly one should not put too much stake in what the experts predict for financial markets year to year. The bottom line is you can’t predict the markets in the short term. What is predictable is that markets will advance over time, so let time be your friend.

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