Is There a Method to the Badness?
By Vince Foster Aug 27, 2012 10:55 am
Not all market strategists are created equal.
In looking at the underlying numbers, the chart Bloomberg used understates the difference between the price targets and actual performance. Because the forecasts represent year-end price targets, I decided to run the chart with the S&P 500 at a 12-month lag. You get a very different picture with a massive discrepancy between target and price.
You can see on the chart that price targets get ratcheted up at the turn of the year. I decided to take each year-end price target and measure it against actual performance from the following year. What I found were some very interesting trends.
As the article states, the data goes back to 1999. Since then, the average strategist target for the S&P 500 had missed the actual year-end price by over 10% both higher and lower in seven out of the 12 years. In the five years where targets were within 10% of the actual price, only in 2002 and 2003 did they hit "the swing," which means that they caught the beginning of a trend. In fact, 2002 was the banner year in which the average target was for a 25% gain with the market actually returning 26%.
However, generally speaking, when you needed targets most, they failed the worst. When the market was entering a bear cycle in 2000 and 2001, the average target overshot by 27% and 33% respectively. In 2007, they overshot by 42% -- and in fact, in January 2008, they top-ticked the market with the highest year-end target of 1603, which was 48% above the year-end actual close of 825.
It wasn't just the tops they missed; the largest deficits occurred when markets were entering bull cycles. In both 2004 and 2005, when the average target implied negative returns, they undershot by 10% and 15% respectively. In 2008 the year-end target for 2009 implied a 4% return, which undershot the 24% actual return by 19%. In 2009, the target implied a negative 4% return vs. the actual 13%, missing by 17%. At the end of 2011, the 2012 year-end target averaged 1282, which was projecting basically a flat year vs. the current return of 12%, potentially setting up for another double digit miss.
The bottom line is that when investors needed Wall Street strategists to be most cautious, they were the most aggressive -- and when investors needed them to be the most aggressive, they were the most cautious. The years when they were the most accurate (with the exception of 2002) are when you needed them the least. What is behind this consistent incompetence?
I can't speak to each individual strategist's methodologies. But if I had to guess, I would suspect most work from bottoms up and determine a year-end earnings number for the S&P 500, and then assign a multiple to come up with a price target. What's interesting is that if you examine the current range of earnings and targets, you get varying multiples, which begs the question: How do they calculate the multiple and then how does the market actually price it?
No positions in stocks mentioned.