By: Andrew J. Willms
President and CEO of The Milwaukee Company
Last year once again demonstrated how unreliable yearly forecasts can be and often are. In December 2019, the median of Wall Street forecasters expected the S&P 500 would rise 2.7% in 2020. With apologies to Harry Doyle in Major League, that pitch was “j-u-s-t a bit outside”.
This week I’d like to conclude my series of posts on market predictions by discussing some recent forecasts that I consider to be debatable, at best.
Questionable Prediction 1: The stock market will continue its current torrent pace.
The Dow climbed 7.5% last year, while the S&P rose 16.6%. For the Nasdaq, it was the best year since 2009 with a 48.0% gain. Despite their horrendous record, Wall Street analysts are once again making bullish 2021 predictions for the stock market. Their consensus outlook: the S&P 500 will reach 4,000 by year end, which equates to a gain of approximately 9.4% in 2021.
The Federal government’s seemingly unlimited willingness to pump additional liquidity into the economy means stocks could continue to trend higher. However, doing so comes at a significant cost (including a falling dollar, increased potential for inflation, greater wealth disparity, etc.), which means the punch bowl will have to be pulled at some point. On top of that, the U.S. economy continues to struggle and the Covid-19 pandemic has taken a serious turn for the worse.
Moreover, the mathematical concept known as mean reversion adds credence to the notion that we are probably in the latter stage of the current equity market rally. Simply put, mean reversion refers to the propensity for returns to revert to the long-run average level. Or as Sir Isaac Newton might have put it: What goes up, must come down.
Questionable Prediction 2: Inflation will remain low for the foreseeable future.
A recent article published by Bloomberg described inflation as a “mirage”. According to economists cited in the article, “2021 will be a year plagued by numerous unwarranted inflation scares. Consumer inflation will remain weak over the medium term -- until the economy fully absorbs the slack resulting from the pandemic.”
The prevailing view seems to be that as long as rates and bond yields remain below 1%, central banks can continue with “quantitative easing” (printing money to buy securities, usually government bonds) with minimal inflation risk. World debt now stands at approximately $280 trillion, which is about $130 trillion greater than it was during the global financial crisis of 2008-2009, according to International Money Fund statistics. In my view, such aggressive monetary policy with no historical benchmarks should be met with a good deal of trepidation.
Questionable Prediction 3: Actively managed funds will consistently outperform their quantitatively managed counterparts.
Bloomberg also recently reported that stock-picking fund managers outperformed quantitative portfolio managers, who utilize rules-based computer algorithms to guide their investment decisions. Two reasons for the sudden reversal in fortunes were identified.
• First, many stock pickers were rewarded for their large bets on tech stocks and initial public offerings. While these bets paid off handsomely in 2020, volumes of academic research have demonstrated that it is unlikely that traders will be able to consistently outperform the market in the years to come. And for the few stock pickers able to accomplish the feat, their outperformance is more likely the result of luck than skill.
• Second, many strategies that use data to inform investment decisions had a difficult time keeping up with the never-before-seen market movements that were brought on by the Covid-19 pandemic. If nothing else, this year taught us that quantitative strategies that use more recent data can better cope with highly volatile markets. Furthermore, rules-based portfolio managers need to be prepared to use their own judgment when they see the market behaving in unanticipated ways.
2020 was a year that will not soon be forgotten, and 2021 is off to a memorable start too. Fortunately for market forecasters, year-end predictions tend to be quickly forgotten (except when the forecaster is right, in which case he or she can be counted on to never allow anyone within shouting distance to forget it).
There’s an old saying in the forecasting game that the best antidote to move attention away from your last prediction is to continually offer new projections. On that score, at least, Wall Street is (still) batting a thousand.
Thank you for reading,
Andrew J. Willms