The Problem With Forecasts
We can’t predict the future – if it was actually possible fortune tellers would all win the lottery. They don’t, we can’t, and we aren’t going to try. However, this doesn’t stop the annual parade of Wall Street analysts from pegging 12-month price targets on the S&P 500 as if there was an actual science behind what is nothing more than a “WAG.” (Wild Ass Guess).
In reality, all we can do is analyze what has happened in the past, weed through the noise of the present and try to discern the possible outcomes of the future.
The biggest single problem with Wall Street, both today and in the past, is the consistent disregard of the possibilities for unexpected, random events. In a 2010 study, by the McKinsey Group, they found that analysts have been persistently overly optimistic for 25 years. During the 25-year time frame, Wall Street analysts pegged earnings growth at 10-12% a year when in reality earnings grew at 6% which, as we have discussed in the past, is the growth rate of the economy.
Ed Yardeni published the two following charts which shows that analysts are always overly optimistic in their estimates.
This is why using forward earnings estimates as a valuation metric is so incredibly flawed – as the estimates are always overly optimistic roughly 33% on average. Furthermore, the reason that earnings only grew at 6% over the last 25 years is because the companies that make up the stock market are a reflection of real economic growth. Stocks cannot outgrow the economy in the long term…remember that.
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