Year-End Stock Forecasts: Still a Guessing Game

Year-End Stock Forecasts: Still a Guessing Game

iStockphoto/The Fiscal Times

As the end of 2012 draws near, investment strategists, one after another, have been issuing their annual prognostications for the stock market. This is always a rather high-risk activity, even though most of us tend to pay more attention to the actual forecast than to whether or not a specific analyst proves to have made the right call some 13 months down the road.

The truth is that unless an analyst is dramatically right – predicting a market blowup that then takes place, or a giant rally – or dramatically wrong (remember Meredith Whitney’s big bearish call on municipal bonds a few years back?), we tend not to hold most of these pundits accountable for their predictions. That’s probably going to be even more fortunate this year, as the image visible in the prognosticators’ crystal balls is likely to be even more murky than usual.

Just take a look at the forecasts of Adam Parker of Morgan Stanley (MS) and David Kostin of Goldman Sachs (GS). The former thinks the most likely scenario is that the S&P 500 index will wrap up 2013 at around 1434, just a smidgen above where it ended last week at 1416. On the other hand, Goldman Sachs is predicting that by December 31, 2013, the S&P 500 could be trading at about 1575.

Investors and market analysts like to talk about “visibility”; they usually trot out the phrase when they are having trouble getting insight into the factors that weigh most heavily on a company’s ability to generate profits, or on the market’s ability to translate those corporate profits into stock market returns. Throughout much of 2012, a lack of visibility has become a major headache for stock market participants, a phenomenon reflected in the sometimes sudden shifts from “risk on” to “risk off” investment strategies.

It’s hard to see how that is going to change much in 2013. The future value of stocks in the S&P 500 will depend greatly on what happens, week by week and month by month, in a wide variety of areas. How fast will the economy grow; how fast will corporate profits grow? What impact will the ongoing European crisis have on the global economy and thus on corporate profits? What really is happening in China’s economy?

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Important “first order” questions of this kind can at least be incorporated into models, and analysts can study what happens when they input different variables into their equations. But there are also the “unknown unknowns,” as former Defense Secretary Donald Rumsfeld famously dubbed them. The Japanese tsunami; the unending tensions in the Middle East; the risk of terrorist attacks or a military conflict with Iran all fall into this category. We already have seen how Hurricane Sandy wreaked havoc on the infrastructure of part of the U.S. Northeast and may still put a big dent in the GDP of the United States for the fourth quarter of 2012. By their very nature, these kinds of exogenous events are more likely to be a negative for financial markets, and most pundits will admit that their forecasts are based on the best possible scenario, taking into consideration the “known unknowns.”

With the bickering in Washington continuing as the clock ticks down to the end of the year, the prospect of mandatory tax hikes and spending cuts looms larger on the horizon. That’s a big factor that makes forecasting what will happen to the S&P 500 next year even more perilous than usual. The odds may be heavily in favor of some kind of compromise being hammered out in Congress – but those odds also favor that compromise being temporary, and involving some kind of spending cut/tax hike combination. The chances of Congress agreeing on even a workable framework for future budget negotiations? Well, personally, I’d rather stock up on lottery tickets than bet on that taking shape and I doubt I’m alone. That alone casts a big cloud over any macro-level forecasts.

Still, there is an outside chance that a big bipartisan agreement on how to move forward with debt and deficit reduction plans could spark what would certainly be a gargantuan stock market rally – one that could drive the average P/E multiple for the S&P 500 from its current level of around 13 to well above its historic average of 15.

But even if our politicians pull off this miracle, we may need some more for markets to remain robust. There is Europe to worry about – and a decent portion of S&P 500 companies rely on Europe for a chunk of their corporate profits. And then there’s China, where anxiety may have recently given way to some increased confidence that one of the most powerful and fastest-growing economies in the world may not be slowing as dramatically as pundits had feared. The country’s purchasing managers index jumped to 50.6, on a scale in which a reading above 50 marks an expansion; new orders are climbing still further. Indeed, Morgan Stanley’s Parker is now taking a rosier view of China, suggesting it as a 2013 investment theme.

Forecasting is always a tricky business, but basing an investment strategy on something as unclear as the outlook for the S&P 500 over a full 365-day period strikes me as downright foolish. The ritual of publishing these predictions may be hard for pundits to break, but if you can break the habit of viewing them as a prism through which to evaluate your portfolio and your investment strategy, that would be wise.

Markets simply don’t move in annual cycles. Sure, 2008 will go down in history as the year of the financial crisis, but the roots of the drama were sown years earlier and the markets peaked in 2007, for instance. This year it is simply more problematic than ever, given the number of “known unknowns,” making predicting 2013 returns as difficult as trying to score a bull’s-eye on your dartboard while wearing a blindfold.

I’d suggest that you leave off the blindfold, and put on blinkers instead to shield yourself from the year-end forecasting mania. Focus on the companies in your portfolio; the risks associated with your low-risk investments and thinking about what big surprises might hit in the coming months and how you might prepare for and think about reacting to them. Remember that markets never stand still, and taking their pulse today may give you some insight as to what the short-term risks are but doesn’t tell you much about where they’ll be in six or eight months’ time.