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The Terrible Track Record of Wall Street Forecasts

This quote, attributed to Yogi Berra, captures the essence of the problem with predictions: “Prediction is very difficult, especially about the future.”

The financial media features stock market “experts” who confidently predict the market's direction, which stocks are likely to become “winners,” and which actively managed mutual funds will outperform.

Investors often rely on these predictions when buying and selling stocks and bonds.

Sometimes they are correct, but rarely more frequently than you would expect from random chance.  When they get it right, they quickly anoint themselves as gurus with unique insight into the future.  When they’re wrong, they rarely accept accountability.

What is the actual track record of Wall Street forecasts?

It’s not pretty.

Terrible track record

One study looked at the track record of stock market “experts” who predicted the market's direction.

Their findings were eye-popping.

Overall their accuracy rate was only 47%, less than you might expect from random chance.

Jim Cramer, a fixture on CNBC, had an accuracy rating of 46.8% based on 62 forecasts.  

Abbey Joseph Cohen, formerly a partner and chief U.S. investment strategist at Goldman Sachs, fared even worse.  Her accuracy rating was only 35%, well below the average of 47%.

Another study analyzed a dataset consisting of 6,627 forecasts made by 68 forecasters.  It found that while some forecasters did “very well,” the “majority perform at levels not significantly different than chance.”

Overall, only 48% of forecasts were correct.

Over 20 years from 2002-2021, another report (discussed here) found the average difference between target price estimates from stock market “experts” at the beginning of the year and actual prices of the index for the same year was a staggering 8.3%.

You can’t predict the unpredictable.

The Efficient Markets Hypothesis states that new information about securities is immediately reflected in stock prices.  Therefore, a price change results from new information, which is impossible to predict.

Information that can impact stock prices can be idiosyncratic to a particular stock (like good or bad earnings), a technology change that impacts an entire industry, or a geopolitical event that affects the whole stock market.  There’s no way to predict these events or the impact they will have on market prices.

The next time you hear or read a prediction about the direction of a stock or the stock market, ask yourself:  “Does this person know what tomorrow’s news will be?”

Then ignore their prediction.

Don’t rely on analysts

Stock market analysts are paid to focus on specific stocks and make predictions about the future performance of that stock.

Here’s why you shouldn’t rely on them.

Conflicts of interest

Analysts employed by investment banks may have meaningful conflicts of interest, especially if the bank is handling the underwriting of a public offering for a company that is the subject of a report by the analyst.

It is in the interest of the investment bank for the public offering to be successful.  A negative report on earnings by the analyst could undermine that effort.  It’s difficult to see how the analyst could remain objective.

Even when there is no imminent public offering, an analyst may be pressured to issue a favorable report to curry favor with actual and potential clients of the investment bank.

Decision fatigue

Stock market analysts are required to cover a number of different companies.  They also need to revise their forecasts when necessary.  

According to an article by David Hirshleifer, published by the National Bureau of Economic Research, “forecast accuracy declines over the course of a day” as the number of forecasts increases.  

This “decision fatigue” also increases the probability that the analyst will take a quick shortcut, like reissuing a previous forecast or agreeing with the consensus forecast.

First impression bias

Hirshleifer examined over 1.6 million firm-analyst observations from 1984-2017.  He found that an analyst's first impression of a company (based, for example, on stellar earnings) positively impacted future forecasts.

Recency bias

Analysts also appear to be unduly influenced by recent events.

The same study found that analysts placed “greater weight on recent experiences” and their earliest experiences than on their intermediate experiences.

Other issues

According to this article in CBS News, analysts often can’t anticipate factors impacting earnings, like changing customer habits and competitive threats.  This inability, coupled with pressure to issue favorable reports and an overall reluctance to acknowledge bad news, causes analysts “[L]ike ostriches...to put their heads in the sand.”

Daner Wealth doesn’t rely on forecasts when making investment recommendations.

You shouldn’t either.

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The Efficient Markets Hypothesis states that new information about securities is immediately reflected in stock prices. Therefore, a price change results from new information, which is impossible to predict.

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