Oh those share price forecasts
It is the start of a new year and once again, the press is full of reports on the share price forecasts for the coming year by strategists and equity analysts everywhere. Time then to take another look at the usefulness of these forecasts.
Bloomberg asks a bunch of strategists every month where they expect major stock market indices to end at the end of the calendar year. At the same time, stock analysts submit their target prices for the stocks they cover to Bloomberg which allows Bloomberg to aggregate these individual share price targets into a bottom-up aggregate for an index. The table below shows the latest forecasts for the major US and European indices both by analysts (bottom-up) and strategists (top-down).
Bottom-up and top-down index forecasts for 2024
The first thing to notice is the glaring difference in opinion between bottom-up analyst forecasts and strategists. If you believe equity analysts, the S&P 500 will rally 7.9% in 2024 (that is price appreciation ex dividends), while European markets are expected to provide double-digit returns. That would mean we have another good year ahead of us. Not as good as 2023, but still a very good year and I think no reader would be angry at the end of this year if these returns materialise.
But if you believe strategists who look at the world from the top down you should strap in for a really bad year. On average, strategists expect the European market to move sideways, and both the S&P 500 and the FTSE 100 to rise in the low single-digits, essentially matching inflation but not more. That would mean you would probably be holding a ton of cash or bonds which provide returns that are likely to be higher than the equity returns expected by strategists.
So, is this going to be another strong year for equities or such a bad year that one might as well sell all equities at once?
The answer depends on who you believe. Mind you, the same strategists that expect stock markets to show poor performance in 2024 also expected the S&P 500 to rise by 6.2% in 2023. In the end, the market rose 24% plus dividends.
To look at it a bit more systematically, I provide a chart of the last 20 years of forecasts for the S&P 500 both from analysts bottom-up and strategists.
Forecast returns vs. actual outcome for the S&P 500
Several things stand out:
Strategists are chronically pessimistic. On average, they predicted annual index changes for the S&P 500 of 4.3% p.a. for the S&P 500. This is well below the actual annual return of 9.8% the index managed to achieve.
Bottom-up analyst forecasts are systematically overoptimistic. On average, the bottom-up forecasts for the S&P 500 showed a return for the S&P 500 of 11.6%, well above the actual return of 9.8%.
A simple forecast of a 7.5% return for the S&P 500 (the average annual price change since the end of World War II) would have been better than either the analyst bottom-up forecasts or the strategists’ forecasts. Over the last twenty years, it would have been slightly pessimistic, but the root mean square error (RMSE) as a measure of forecast accuracy of this simple 7.5% forecast was lower than either the RMSE of the bottom-up analyst forecasts or the strategists’ forecasts.
If you don’t care about the actual level of returns but just want to get the direction (up or down) right, then the bottom-up analysts get the direction of the market right 73% of the time, compared to 70% for the simple 7.5% rule. Meanwhile, strategists get the direction right only 52% of the time, i.e. their forecasts are about as good as flipping a coin.
This brings me to the conclusion I have made before in more detail: Don’t bother with share price or index targets. You are wasting your time because nobody knows where the index or individual share prices will be at the end of this year. This is not what analyst and strategist research is about. Their analysis is about identifying the major driver of markets and then providing guidance on risks and opportunities, nothing more and nothing less.