Wall Street’s Year-End Forecasts

The chart above is from Bespoke Investment Group, and it lists Wall Street’s consensus for the market’s return over the coming year compared with how well the market actually did.

As you can see, Wall Street’s track record ain’t that good. On average, Wall Street has missed by 13.1%. If you simply said 9% every year, you would have beaten that.

Looking at the chart, it’s interesting how narrow Wall Street’s predictions are. Most of the projections listed above are between +5% and +10%. None was negative. The standard deviation of the market’s actual returns is four times that of the forecasts.

Here’s a scatterplot. The Y-axis is Wall Street’s forecasts and the X-axis is what really happened. The r-square is 0.01.

They kept the data ranges the same for both axes to show you how narrow Wall Street’s forecasts are.

Now here’s the same scatterplot but with one crucial difference. I set the coming year’s forecast against the just-completed year. The correlation is semi-strong (r-square of 0.59), but what’s striking is that the slope is negative.

What this means is that Wall Street’s forecasts don’t tell you much about the coming year, but they say a decent amount about the year that just ended. The downward slope means that historically, analysts have predicted a bad year will be followed by a mildly good one, and a good one will be followed by a mildly bad one.

In other words, these folks get paid tons of money to predict simple regression to the mean. What the equation means is that to be a Wall Street analyst, start with 10% as your baseline prediction. Then take whatever the market did last year and divide it by 5. Now subtract that from 10%, and presto, you now have your expert forecast (or at least 58% of the way there)!

Posted by on December 28th, 2017 at 2:09 pm


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