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Year-End Stock Forecasts: Still a Guessing Game

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Take a look at the forecasts of Adam Parker of Morgan Stanley and David Kostin of Goldman Sachs.

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As the end of 2012 draws near, investment strategists, one after another, have been issuing their annual prognostications for the stock market. This is always a rather high-risk activity, even though most of us tend to pay more attention to the actual forecast than to whether or not a specific analyst proves to have made the right call some 13 months down the road.

The truth is that unless an analyst is dramatically right – predicting a market blowup that then takes place, or a giant rally – or dramatically wrong (remember Meredith Whitney's big bearish call on municipal bonds a few years back?), we tend not to hold most of these pundits accountable for their predictions. That's probably going to be even more fortunate this year, as the image visible in the prognosticators' crystal balls is likely to be even more murky than usual.

Just take a look at the forecasts of Adam Parker of Morgan Stanley (NYSE:MS) and David Kostin of Goldman Sachs (NYSE:GS). The former thinks the most likely scenario is that the S&P 500 Index (INDEXSP:.INX) will wrap up 2013 at around 1434, just a smidgen above where it ended last week at 1416. On the other hand, Goldman Sachs is predicting that by December 31, 2013, the S&P 500 could be trading at about 1575.

Investors and market analysts like to talk about "visibility." They usually trot out the phrase when they are having trouble getting insight into the factors that weigh most heavily on a company's ability to generate profits, or on the market's ability to translate those corporate profits into stock market returns. Throughout much of 2012, a lack of visibility has become a major headache for stock market participants, a phenomenon reflected in the sometimes sudden shifts from "risk on" to "risk off" investment strategies.

It's hard to see how that is going to change much in 2013. The future value of stocks in the S&P 500 will depend greatly on what happens, week by week and month by month, in a wide variety of areas. How fast will the economy grow? How fast will corporate profits grow? What impact will the ongoing European crisis have on the global economy and thus on corporate profits? What really is happening in China's economy?

Important "first order" questions of this kind can at least be incorporated into models, and analysts can study what happens when they input different variables into their equations. But there are also the "unknown unknowns," as former Defense Secretary Donald Rumsfeld famously dubbed them. The Japanese tsunami, the unending tensions in the Middle East, the risk of terrorist attacks or a military conflict with Iran all fall into this category. We already have seen how Hurricane Sandy wreaked havoc on the infrastructure of part of the US Northeast and may still put a big dent in the GDP of the United States for the fourth quarter of 2012. By their very nature, these kinds of exogenous events are more likely to be a negative for financial markets, and most pundits will admit that their forecasts are based on the best possible scenario, taking into consideration the "known unknowns."

With the bickering in Washington continuing as the clock ticks down to the end of the year, the prospect of mandatory tax hikes and spending cuts looms larger on the horizon. That's a big factor that makes forecasting what will happen to the S&P 500 next year even more perilous than usual. The odds may be heavily in favor of some kind of compromise being hammered out in Congress – but those odds also favor that compromise being temporary, and involving some kind of spending cut/tax hike combination. The chances of Congress agreeing on even a workable framework for future budget negotiations? Well, personally, I'd rather stock up on lottery tickets than bet on that taking shape and I doubt I'm alone. That alone casts a big cloud over any macro-level forecasts.
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