Investment Insights: June 2017

The Financial Markets have been on our minds here over the last few months but maybe not for the reasons you think, which leads us to our topic of Predictions.

2017-06-30

Hello and welcome to this end of financial year edition of Investment Insights.

The Financial Markets have been on our minds here over the last few months but maybe not for the reasons you think, which leads us to our topic of Predictions.

Twice a year, we are inundated with opinions, analysis and “predictions” of where financial markets are headed in the next 12 months, what sectors we should be investing in or what is the ‘must own’ stock for the next 12 months. A recent article in the Australian Financial Review highlighted that the “Predictions for sharemarket wrong again” noting amongst other things that:

“Despite all the optimism around President Donald Trump's aggressive tax and growth policies, when asked about the prospects for the stock market in 2017, investors had to go back to 2005 to find the last time Wall Street's soothsayers were this bearish. Turns out they should have stuck to their knitting. The share market has done well, so far. As the halfway mark of the calendar year approaches the Dow Jones, S&P 500 and Nasdaq have all chalked up record highs, while predictions about bonds and currencies have also turned out to be wrong.

In January, Wall Street's consensus forecast call for the S&P 500 was for not much more than a 5.5 per cent gain in 2017, the smallest increase since a 2.8 per cent forecast 12 years ago, according to Bespoke Investment Group. As June 30 approaches, however, the S&P 500 is up almost 9 per cent, while the Nasdaq is up 14 per cent and the Dow Jones 8 per cent. In contrast the major S&P ASX 200 index is up just over 2 per cent. Wall Street analysts are usually bullish. Since 2000, they have predicted that, on average, the S&P 500 would rise by about 9.5 per cent a year, according to calculations by Bespoke Investment Group, when it has gone up by 3.9 per cent.

The one year they turned bearish it's been the wrong call.”

There is a consistent trend of most predictions being off the mark with a another example going all the way back to 2010 and our friend Paul the Octopus. For those of you who may remember, Paul made a series of successful picks of winners on the 2010 World cup by correctly selecting the glass box containing the winning team’s flag (and muscles for his lunch). The irony of this was not lost on one of our regular contributing writers, Jim Parker who sagely observed that “the attribution of the power of divination to a cephalopod, however ridiculous, is not that different to how many people attribute to economists the power to accurately and consistently forecast the paths of stocks, interest rates and currencies. The only difference is that our eight-armed soccer-following underwater friend seems to get it right more often than his two-armed land-loving brethren!”

One of the most interesting observations around the twice yearly market prediction season comes from a recent New York Times article “Wall street’s annual stock forecasts bullish and often wrong”  in that there appears to be an inherent bias in most of these predictions, towards the upside, which the author posits encourages investors to pour fresh money into the markets, helping asset management companies to enjoy rising profits. The article gave the example of 2008:

“Consider the calamity of 2008. If you had money in stocks that year, you would probably remember. The S.&P. 500 fell 38.5 percent in the course of those 12 months. It would have been very useful to have received advance warning that stocks were about to plummet, but the Wall Street consensus did not ring out an alarm. On the contrary, the forecast for 2008 was unusually bullish, calling for a rise of 11.1 percent. Wall Street missed the mark by 49 percentage points that year.”

Now obviously 2008 is an easy target given that it could be send that it was the 1929 crash of the modern generation. So to look at a larger sample size we turn to a recently published paper “Bailey, David H. and Borwein, Jonathan M. and Salehipour, Amir and Lopez de Prado, Marcos, Evaluation and Ranking of Market Forecasters (May 31, 2017)” which looked at 6,627 forecasts made by 68 different forecasters. The conclusion

“Across all forecasts, the accuracy is around 48%. Also, the distribution of forecasting accuracy is very similar to the proverbial bell curve implying that the outcomes are due to randomness. This is further acknowledged by the outcomes of the Wilcoxon Signed Rank test. We observed that two-thirds of forecasts predict short-term returns and as far as only a month, and the remaining one-third predict periods over one month.

Following the more random nature of short-term returns, this is another argument supporting our findings of random performance of forecasters, and that existence of little skill in doing so. Finally, the highest accuracy value is 78.69%, and while only about 6% of forecasters have their accuracy values between 70% and 79%, the majority of forecasters (two-thirds) have an accuracy level below 50%.”

So the majority of forecasters are right, less than half the time which is eloquently summarised in the very last sentence where the authors note that the majority of forecasters perform at levels not significantly different than chance, which makes it very difficult to tell if there is any skill present.

If you would like to discuss any aspect of your strategy and investments, or you would like help putting one together, please contact one of our advisors today.

Daniel Minihan
Partner, Private Clients and Wealth

Matthew Oakey
Partner, Private Clients

David Foord
Senior Manager, Wealth Management

Matthew Baum
Private Client Advisor, Wealth Management

Keegan O'Rourke
Private Client Advisor, Wealth Management

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