Here we are at quarter end and, get ready, here come all the market predictions from Wall Street Chief Economists and strategy professionals.
The title of this post speaks to our feelings about these market prognostications. It comes from the founder of Neuberger Berman, Roy Neuberger. When I joined Neuberger Berman years ago, I had the opportunity to meet with Roy and speak with him about his philosophy, which included a general skepticism about those who made market predictions. For much of firm’s history, Neuberger Berman never had a Chief Economist or firm-wide strategist. When asked about this, Roy would famously, and gruffly, say,
“If I had one I would have to pay them. And, if I pay someone, I feel compelled to listen to them.”
In a fun way, he was saying that he did not think Wall Street economists were worth much.
Much has been written about the inaccuracy of economic and market forecasts to include a study by a Federal Reserve bank on the prowess of their own forecasting. Below is a quote from a report published in February of this year by the Federal Reserve Bank of San Francisco (FRBSF) based on a study of the Federal Reserve Open Market Committee’s Summary of Economic Projections (SEP):
“Over the past seven years, many growth forecasts, including the SEP’s…, have been too optimistic. In particular, the SEP forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently over-predicted the speed of the recovery that started in June 2009.”
Beyond words, the below chart says it all.
The following is how the Fed explains this illustration:
“Figure 1 shows that the SEP growth forecast for 2008 never turned negative. At the time, the mainstream view was that the U.S. economy would avoid a recession despite the ongoing housing market turmoil. The actual growth rate for 2008 turned out to be -2.8% (the largest annual decline since 1946). The SEP growth forecast for 2009 did not turn negative until January 2009…, after the Lehman Brothers bankruptcy in September 2008.”
For those you wish to read the full report, it can be found by clicking on the following link:
FRBSF Economic Letter – Persistent Overoptimism About Economic Growth – February 2, 2015
Some might say, “this doesn’t tell the full story”, “the 2008-2009 financial crisis was hard to predict” or, my favorite, “economic conditions are indeed hard to predict, but with hard work we can accurately estimate future earnings.”
Unfortunately, independent analysis of analysts’ estimates and projections suggests that “this just ain’t so.”
As an example, McKinsey & Co. produced a study in 2001 about the accuracy of earnings estimates, which was then updated in 2010. The following quote summarizes their findings:
“Analysts, we found, were typically overoptimistic, slow to revise their forecasts to reflect new economic conditions, and prone to making increasingly inaccurate forecasts when economic growth declined. On average, analysts’ forecasts have been almost 100 percent too high.”
Like the FRBSF chart, pictures can speak louder than words. In the chart below, the light green line represents Wall Street earnings forecasts. The blue line reflects what actually happened.
The full McKinsey & Co. reports can be found at the following:
Prophets and Profits – McKinsey Quarterly – October 2001
What the charts above highlight, and the McKinsey study has twice observed, is that Wall Street economists and analysts can be herd animals and get anchored on a trend. They tend to be late to revise up, late to revise down and tend to move in groups.
Beyond anchoring, I believe this is also due to pain avoidance.
It is painful to be right – early – on Wall Street.
If an analyst is out in front and seems to be wrong for a quarter or two, the pain in terms of job security and reduced bonus potential can be high.
In writing this, I am not suggesting that we shouldn’t follow useful information being published or not to strive to make informed decisions based upon all of the available information. I am just cautioning that we should not get overly anchored on estimates of the future.
Versus hiring a Chief Economist or strategist, or paying Wall Street to provide us with research that the evidence consistently says is wrong, at Fiduciary Wealth Partners we try to stay anchored on Roy Neuberger’s old line.
This additional quip about forecasts that Wall Street professionals often say in private might say it the best:
“Never in Doubt, But Often Wrong.”