What I find difficult to understand is that the data used by you to create the two charts in your post must be common knowledge. So why is it that these are still put out every year and used to make strategic decisions by companies (and probably governments as well!!)?
I am assuming that the people putting out these forecasts try to learn from past mistakes. So why is there no improvement in the accuracy of the forecasts? Maybe once the forecasts are out and people/agencies/governments absorb these numbers, the actions they take invalidates the original forecasts. Or maybe they are just consistently wrong and no one cares...
Have you ever tried to leave anything under a five-star rating on eBay or ÜberCab? Can it really be possible that *every* vendor or driver one sees has 99.75% positive reviews? Still, day after day, things are bought and sold, and rides are ordered and executed. Similarly, Goodhart's Law says "When a measure becomes a target, it ceases to be a good measure". "People will hack the metric, and it will lose its value."
I think there are a couple of reasons why these forecasts are produced every year:
1. While the lack of accuracy of these forecasts is well known, it is largely unknown what the true uncertainty around them is. The vast majority of professional investors is incredibly overconfident in their ability to forecast. they would likely argue that the grey area around the forecast in the second chart is maybe plus/minus 5% not 38%.
2. Who says forecasters learn from their past mistakes? the job of a forecaster on the sell side is to get as many meetings with clients as possible because that is how they are paid. and one of the simplest ways to get meetings is to make outrageous forecasts. For stock analysts that means outrageously optimistic forecasts about glamour stocks like NVidia or Tesla and for strategists and economists the best way to get meetings and media coverage is to be bearish and promise a crash (see Rubini, Taleb, Marc Faber, etc.).
3. Even if 1 and 2 above are not present, there is still value in these forecasts in providing a false sense of security. That is the reason why we have so many meaningless rituals like setting up Christmas trees and lighting fireworks at new year's eve. they make no sense and are objectively a waste of money (in the case of fireworks you are almost literally setting money on fire) but they give us a sense of security and rhythm. It's the same with these forecasts. It's a tradition that gives us a sense of security.
I spent 16 years as sell-side analyst, and have spent the last 21 as a buy-side analyst, research director, and portfolio manager, so I've been on both the production and consumption side of street earnings/markets forecasts for almost four decades, both producing and consuming the proverbial sausage one swears to never eat once one's visited the sausage factory.
Cooking up outlier forecasts is *not* career enhancing. In fact, the market data service providers (First Call, IBES, Reuters, Bloomberg, etc.) would compound this by actually calling you up to tell you that your estimate would be dropped if it was more than one standard deviation away from the street mean estimate, and the research director who paid you didn't want your firm to not appear in the consensus listing. Everything is presented on a high-pressure morning meeting to a room full of grizzled institutional salespeople who have to "smile and dial" to sceptical clients every day. If you come in with a "buy" recommendation with 10% upside, that's "not enough to make it interesting". If you come in with 50% upside, that's "ridiculous". If you come in with 0%, but that's okay because you think the market (or industry subsector) will be down 10%, that's "not your job to call". So +20% for "buy" recommendations and +10% for "holds" are the magic numbers that organically emerge; even the rare "sell", not often seen in the wild, usually gets a "flat" so that your in-house investment bankers at least have one less thing they have to sheepishly explain to company managements with whose personal wealth you're messing. Considering the fact that 95% of ratings are buys or holds, and probably 2/3rds of those are buys, aggregated bottom-up analyst forecasts are inevitably on the high side. It's like that old joke about everyone's hometown being "where all the men are strong, all the women are good-looking, and all the children are above average".
I have worked at places and seen competitors who've tried *everything* imaginable to market-normalize forward projections, hence "market outperform" sorts of ratings nomenclature; if your "buy" recommentation is "only" down 5% and the market is down 10%, then you ostensibly win ... but you really don't because you're only supposed to recommend stocks that go up. That's why these systems inevitably fade, as people prefer the simplicity of "buy, hold, or sell". There was also *huge* resistance to publishing "point estimate" target prices from analysts, but salespeople demanded them because it saved a math step from placing a multiple on an EPS forecast, so everyone eventually caved in. At the end of the day, nobody cares, because analysts are primarily there to provide context and simplify industry analysis for busy portfolio managers who have to pretend to understand the whole world all at once. Some well-paid analysts are *so* predictably wrong that they provide a valuable service as perfect contrarian signals. Some can be needled by hedge funds into ratings changes that cause tradable events that are fun for them, generate some commissions for the firm, but are usually not good for the analyst. Concierge service is also a big part of the job (field trips, conferences, general management introductions/access https://open.substack.com/pub/gunnarmiller/p/lavish-lunches-no-pulled-punches ), as is being the target of blame-shifting when things go the wrong way.
Strategists can say whatever they want as long as it's never "avoid stocks and buy bonds or real estate or gold this year", and have to always remain glib yet quasi-professorial in the same way that teachers most popular with students are usually the ones from whom they actually learn the least; one brokerage house used to get around the whole problem by having two strategists, one a perma-bull and one a perma-bear, so they were never wrong! I once overheard someone say "strategists will likely have job security until the day they start to haul TV meterologists in front of courts to be judged for all the incorrect weather forecasts no one remembers anyway."
Most pop music singers have very little actual musical skill compared to opera singers, but their music has a good beat you can dance to. As one senior person told me when I was just starting out, "kid, we're in the entertainment business" https://open.substack.com/pub/gunnarmiller/p/the-most-important-conversations .
Lots of additional colour to my post above, though I would disagree with your statement that strategists can say whatever they want as long as they don't say sell all stocks. I think on the sell side that is true, but the moment you go to 'independent' firms that are not attached to investment banks making money off of corporate access and ECM deals the incentive is very much to say sell all stocks and run for the hill because it is the only thing that cuts through the usual noise of all strategists and economists being 'cautiously optimistic' (back in my UBS Wealth Management days we banned that phrase from ever being used in reports, but you have no idea how much some people struggled with avoiding it...).
And yes, I know which company always had a bullish and a bearish strategist. It's the stuff of legends 😂
Finally, on my darker days I call my job 'telling fairy tales to grown ups'. But I haven't given up on the belief (illusion? self-deception?) that I do add value to my clients...
I worked for two companies that were both eventually absorbed into UBS in the mid-'90s, and they had a US strategist (of rather large build, by the way) who'd begin every one of his annual prediction presentations with "I'm still sweating from last year!". The buy-side equity PM equivalent to "cautiously optimistic" is "I'm a fully-invested bear", because most people's fund guidelines ony allow them a maximum of 10% cash in the portfolio, rain or shine. This then allows you to talk trash about macro factors without having to actually change anything in your equity portfolio; indeed, as even just modestly tilting one's holdings a bit more defensively/value-oriented versus growth has only worked for a year or two of the past 15-20, you don't really even have to do that anymore.
After I had moved to the buy-side, I once went to a well-attended group Christmas 2008 lunch in Frankfurt hosted by Noriel Roubini https://en.wikipedia.org/wiki/Nouriel_Roubini , who'd just arisen to prominence by allegedly calling the World Financial Crisis, and was really trying to monetize his "Dr. Doom" status. As Wikipedia says: "In January 2009, Roubini predicted that oil prices would stay below $40 for all of 2009. By the end of 2009, however, oil prices were at $80. In March 2009, he predicted the S&P 500 would fall below 600 that year, and possibly plummet to 200. It closed at over 1,115 however, up 24%, the largest single-year gain since 2003." ... [I]n April 2009, Roubini prophesied that the United States economy would decline in the final two quarters of 2009, and that the US economy would increase just 0.5% to 1% in 2010, in fact the U.S. economy in each of those six quarters increased at a 2.5% average annual rate. Then in June 2009 he predicted that what he called a "perfect storm" was just around the corner, but no such perfect storm ever appeared. In 2009 he also predicted that the US government would take over and nationalize a number of large banks; it did not happen. In October 2009 he predicted that the price of gold "can go above $1,000, but it can't move up 20-30%"; he was wrong, as the price of gold rose over the next 18 months, breaking through the $1,000 barrier to over $1,400." ... "Although he was ranked only 1,474th in terms of lifetime academic citations in February 2024, he was No. 4 on Foreign Policy magazine's list of the "top 100 global thinkers."
I remember thinking a year later, "I'm definitely in the wrong business" ;-)
No, no Klement. You got it all wrong. In my experience forecasters usually get it right when forecasting the past, or if it is for the future, it is sufficiently vague to allow individual interpretation. Vide the forecasts of Nostradamus and the holy books of all religions.
I will spend at betweent 45 and 60 mins per day exercising
My children will get between A and A+ in all subjects at school
Now please don't compare this years' forecasts with the ones I've made in previous years (that's all water under the bridge and today I have all the latest data and forcecasting techniques available).
Please don't compare the results of my waistline or children with other people's results (I do this myself).
I come across the topic of financial forecasts often. Most recently, about 2 weeks back, when someone passed me about a CNBC conversation, they said that the S&P’s 2025 forecast is 9.7%. My reply to this person was the following quote by William Goldman: even though it is from a different domain, it is relevant in almost every scenario when people try to forecast a complex system like the stock market:
“Nobody knows anything...... Not one person in the entire motion picture field knows for a certainty what's going to work. Every time out it's a guess and, if you're lucky, an educated one.”
As humans, we love certainty, which is impossible to find in a complex system. Year after year, almost all forecasts are wrong, but we will still look for them, and the only reason a few are right is pure luck, as a broken clock is right twice a day.
It’s not that forecasts have no value—they can provide a framework for thinking and planning—but they should always be taken with a grain of salt, recognizing the inherent limitations of predicting the future.
Two comments/questions. First, the chart of actual returns versus forecast ranges of returns illustrates that the original bias remains, which is that actual returns lie toward the upper end of the range much more often than not. I wonder if there's a way to fix the forecast ranges so they are unbiased? (Of course, a simple answer would be to raise the ranges by an arbitrary constant, but that's not ex ante what the analysts do.)
Second, one conjecture is that analysts are better at medium-range forecasts than short-term forecasts. For example, Robert Shiller suggests that his "CAPE" ratio is a weak signal of one-year returns but a more powerful signal of, say, 10-year returns. So, I wonder if analyst forecasts of multiyear-horizon returns are more accurate and/or less biased?
In the past, I tried to fix these biased forecasts by finding out what kind of correction one could apply, but I couldn't find anything, unfortunately. Maybe some people smarter than me have found something...
When it comes to long-term forecasts, there are not really that many surveys. there are of course the capital market assumptions from asset managers that come up with 10-year returns, but these are typically model driven and not based on strategists or analysts and their guesses. And if you read this post and the paper referenced therien, you'll find out that these forecasts are also all over the place: https://klementoninvesting.substack.com/p/how-big-is-the-equity-risk-premium
Good morning. This chart you created definitely made my day. 😀
Great post, as usual.
What I find difficult to understand is that the data used by you to create the two charts in your post must be common knowledge. So why is it that these are still put out every year and used to make strategic decisions by companies (and probably governments as well!!)?
I am assuming that the people putting out these forecasts try to learn from past mistakes. So why is there no improvement in the accuracy of the forecasts? Maybe once the forecasts are out and people/agencies/governments absorb these numbers, the actions they take invalidates the original forecasts. Or maybe they are just consistently wrong and no one cares...
Have you ever tried to leave anything under a five-star rating on eBay or ÜberCab? Can it really be possible that *every* vendor or driver one sees has 99.75% positive reviews? Still, day after day, things are bought and sold, and rides are ordered and executed. Similarly, Goodhart's Law says "When a measure becomes a target, it ceases to be a good measure". "People will hack the metric, and it will lose its value."
I think there are a couple of reasons why these forecasts are produced every year:
1. While the lack of accuracy of these forecasts is well known, it is largely unknown what the true uncertainty around them is. The vast majority of professional investors is incredibly overconfident in their ability to forecast. they would likely argue that the grey area around the forecast in the second chart is maybe plus/minus 5% not 38%.
2. Who says forecasters learn from their past mistakes? the job of a forecaster on the sell side is to get as many meetings with clients as possible because that is how they are paid. and one of the simplest ways to get meetings is to make outrageous forecasts. For stock analysts that means outrageously optimistic forecasts about glamour stocks like NVidia or Tesla and for strategists and economists the best way to get meetings and media coverage is to be bearish and promise a crash (see Rubini, Taleb, Marc Faber, etc.).
3. Even if 1 and 2 above are not present, there is still value in these forecasts in providing a false sense of security. That is the reason why we have so many meaningless rituals like setting up Christmas trees and lighting fireworks at new year's eve. they make no sense and are objectively a waste of money (in the case of fireworks you are almost literally setting money on fire) but they give us a sense of security and rhythm. It's the same with these forecasts. It's a tradition that gives us a sense of security.
I spent 16 years as sell-side analyst, and have spent the last 21 as a buy-side analyst, research director, and portfolio manager, so I've been on both the production and consumption side of street earnings/markets forecasts for almost four decades, both producing and consuming the proverbial sausage one swears to never eat once one's visited the sausage factory.
Cooking up outlier forecasts is *not* career enhancing. In fact, the market data service providers (First Call, IBES, Reuters, Bloomberg, etc.) would compound this by actually calling you up to tell you that your estimate would be dropped if it was more than one standard deviation away from the street mean estimate, and the research director who paid you didn't want your firm to not appear in the consensus listing. Everything is presented on a high-pressure morning meeting to a room full of grizzled institutional salespeople who have to "smile and dial" to sceptical clients every day. If you come in with a "buy" recommendation with 10% upside, that's "not enough to make it interesting". If you come in with 50% upside, that's "ridiculous". If you come in with 0%, but that's okay because you think the market (or industry subsector) will be down 10%, that's "not your job to call". So +20% for "buy" recommendations and +10% for "holds" are the magic numbers that organically emerge; even the rare "sell", not often seen in the wild, usually gets a "flat" so that your in-house investment bankers at least have one less thing they have to sheepishly explain to company managements with whose personal wealth you're messing. Considering the fact that 95% of ratings are buys or holds, and probably 2/3rds of those are buys, aggregated bottom-up analyst forecasts are inevitably on the high side. It's like that old joke about everyone's hometown being "where all the men are strong, all the women are good-looking, and all the children are above average".
I have worked at places and seen competitors who've tried *everything* imaginable to market-normalize forward projections, hence "market outperform" sorts of ratings nomenclature; if your "buy" recommentation is "only" down 5% and the market is down 10%, then you ostensibly win ... but you really don't because you're only supposed to recommend stocks that go up. That's why these systems inevitably fade, as people prefer the simplicity of "buy, hold, or sell". There was also *huge* resistance to publishing "point estimate" target prices from analysts, but salespeople demanded them because it saved a math step from placing a multiple on an EPS forecast, so everyone eventually caved in. At the end of the day, nobody cares, because analysts are primarily there to provide context and simplify industry analysis for busy portfolio managers who have to pretend to understand the whole world all at once. Some well-paid analysts are *so* predictably wrong that they provide a valuable service as perfect contrarian signals. Some can be needled by hedge funds into ratings changes that cause tradable events that are fun for them, generate some commissions for the firm, but are usually not good for the analyst. Concierge service is also a big part of the job (field trips, conferences, general management introductions/access https://open.substack.com/pub/gunnarmiller/p/lavish-lunches-no-pulled-punches ), as is being the target of blame-shifting when things go the wrong way.
Strategists can say whatever they want as long as it's never "avoid stocks and buy bonds or real estate or gold this year", and have to always remain glib yet quasi-professorial in the same way that teachers most popular with students are usually the ones from whom they actually learn the least; one brokerage house used to get around the whole problem by having two strategists, one a perma-bull and one a perma-bear, so they were never wrong! I once overheard someone say "strategists will likely have job security until the day they start to haul TV meterologists in front of courts to be judged for all the incorrect weather forecasts no one remembers anyway."
Most pop music singers have very little actual musical skill compared to opera singers, but their music has a good beat you can dance to. As one senior person told me when I was just starting out, "kid, we're in the entertainment business" https://open.substack.com/pub/gunnarmiller/p/the-most-important-conversations .
Lots of additional colour to my post above, though I would disagree with your statement that strategists can say whatever they want as long as they don't say sell all stocks. I think on the sell side that is true, but the moment you go to 'independent' firms that are not attached to investment banks making money off of corporate access and ECM deals the incentive is very much to say sell all stocks and run for the hill because it is the only thing that cuts through the usual noise of all strategists and economists being 'cautiously optimistic' (back in my UBS Wealth Management days we banned that phrase from ever being used in reports, but you have no idea how much some people struggled with avoiding it...).
And yes, I know which company always had a bullish and a bearish strategist. It's the stuff of legends 😂
Finally, on my darker days I call my job 'telling fairy tales to grown ups'. But I haven't given up on the belief (illusion? self-deception?) that I do add value to my clients...
I worked for two companies that were both eventually absorbed into UBS in the mid-'90s, and they had a US strategist (of rather large build, by the way) who'd begin every one of his annual prediction presentations with "I'm still sweating from last year!". The buy-side equity PM equivalent to "cautiously optimistic" is "I'm a fully-invested bear", because most people's fund guidelines ony allow them a maximum of 10% cash in the portfolio, rain or shine. This then allows you to talk trash about macro factors without having to actually change anything in your equity portfolio; indeed, as even just modestly tilting one's holdings a bit more defensively/value-oriented versus growth has only worked for a year or two of the past 15-20, you don't really even have to do that anymore.
After I had moved to the buy-side, I once went to a well-attended group Christmas 2008 lunch in Frankfurt hosted by Noriel Roubini https://en.wikipedia.org/wiki/Nouriel_Roubini , who'd just arisen to prominence by allegedly calling the World Financial Crisis, and was really trying to monetize his "Dr. Doom" status. As Wikipedia says: "In January 2009, Roubini predicted that oil prices would stay below $40 for all of 2009. By the end of 2009, however, oil prices were at $80. In March 2009, he predicted the S&P 500 would fall below 600 that year, and possibly plummet to 200. It closed at over 1,115 however, up 24%, the largest single-year gain since 2003." ... [I]n April 2009, Roubini prophesied that the United States economy would decline in the final two quarters of 2009, and that the US economy would increase just 0.5% to 1% in 2010, in fact the U.S. economy in each of those six quarters increased at a 2.5% average annual rate. Then in June 2009 he predicted that what he called a "perfect storm" was just around the corner, but no such perfect storm ever appeared. In 2009 he also predicted that the US government would take over and nationalize a number of large banks; it did not happen. In October 2009 he predicted that the price of gold "can go above $1,000, but it can't move up 20-30%"; he was wrong, as the price of gold rose over the next 18 months, breaking through the $1,000 barrier to over $1,400." ... "Although he was ranked only 1,474th in terms of lifetime academic citations in February 2024, he was No. 4 on Foreign Policy magazine's list of the "top 100 global thinkers."
I remember thinking a year later, "I'm definitely in the wrong business" ;-)
Wow, exactly what I needed to add to the annual note to my clients. Always wanted to research this topic but never got around to it
No, no Klement. You got it all wrong. In my experience forecasters usually get it right when forecasting the past, or if it is for the future, it is sufficiently vague to allow individual interpretation. Vide the forecasts of Nostradamus and the holy books of all religions.
OK here are my forecasts:
I will lose 1.5 stone
I will spend at betweent 45 and 60 mins per day exercising
My children will get between A and A+ in all subjects at school
Now please don't compare this years' forecasts with the ones I've made in previous years (that's all water under the bridge and today I have all the latest data and forcecasting techniques available).
Please don't compare the results of my waistline or children with other people's results (I do this myself).
The same principles apply to stock forecasts.
New year's resolutions and other short-lived ideas...
I come across the topic of financial forecasts often. Most recently, about 2 weeks back, when someone passed me about a CNBC conversation, they said that the S&P’s 2025 forecast is 9.7%. My reply to this person was the following quote by William Goldman: even though it is from a different domain, it is relevant in almost every scenario when people try to forecast a complex system like the stock market:
“Nobody knows anything...... Not one person in the entire motion picture field knows for a certainty what's going to work. Every time out it's a guess and, if you're lucky, an educated one.”
As humans, we love certainty, which is impossible to find in a complex system. Year after year, almost all forecasts are wrong, but we will still look for them, and the only reason a few are right is pure luck, as a broken clock is right twice a day.
It’s not that forecasts have no value—they can provide a framework for thinking and planning—but they should always be taken with a grain of salt, recognizing the inherent limitations of predicting the future.
Hello again ... here is an interesting and recent paper on the same subject. Still need to read it in depth myself:
https://www.bayes.city.ac.uk/__data/assets/pdf_file/0005/799817/Park_top_downt_Bayes.pdf
Yup, I read that one. It was my first attempt at writing today's post but it led nowhere so I skipped in favour of what you see.
Two comments/questions. First, the chart of actual returns versus forecast ranges of returns illustrates that the original bias remains, which is that actual returns lie toward the upper end of the range much more often than not. I wonder if there's a way to fix the forecast ranges so they are unbiased? (Of course, a simple answer would be to raise the ranges by an arbitrary constant, but that's not ex ante what the analysts do.)
Second, one conjecture is that analysts are better at medium-range forecasts than short-term forecasts. For example, Robert Shiller suggests that his "CAPE" ratio is a weak signal of one-year returns but a more powerful signal of, say, 10-year returns. So, I wonder if analyst forecasts of multiyear-horizon returns are more accurate and/or less biased?
In the past, I tried to fix these biased forecasts by finding out what kind of correction one could apply, but I couldn't find anything, unfortunately. Maybe some people smarter than me have found something...
When it comes to long-term forecasts, there are not really that many surveys. there are of course the capital market assumptions from asset managers that come up with 10-year returns, but these are typically model driven and not based on strategists or analysts and their guesses. And if you read this post and the paper referenced therien, you'll find out that these forecasts are also all over the place: https://klementoninvesting.substack.com/p/how-big-is-the-equity-risk-premium
Have you seen today’s WSJ piece?
https://www.wsj.com/finance/investing/stock-market-forecast-ritual-of-wrong-add89428?st=hXEAd9&reflink=article_copyURL_share
Yes. Jason is a friend of mine and reached out to me after reading the post.