Investors often look for a roadmap, a way to guide them through uncertain times. History is often used to write that script. However, markets are like any sport: rules change, equipment improves, and what worked best in the past may not always apply to the current situation.
Playbooks need constant review, but despite changes, any research designed to guide investors is actually based on two fundamental questions: what will happen, and more importantly, how will the market react?
There is no shortage of forecasts and meaningless opinions in the financial media. Just sound smart, maybe say something controversial, and you can get plenty of coverage. Individuals can also be incentivized to make a name for themselves, build their personal brand and generate more revenue for their business. Fear drives eyeballs and eyeballs bring in the advertising dollars. Unfortunately, it can be easy to merge the opinions that receive the most attention with the opinions that are most accurate. Prediction is difficult and, as history shows, often inaccurate, especially when it comes to the stock market.
The folly of the forecasters
Market strategists at the largest banks typically all have year-end targets for the S&P 500. These get a lot of attention at the beginning of the year and are materially revised every time. Consensus targets for the S&P 500 tend to track prices, not the other way around.
If you just take the past few years as an example, you can see that forecasters were eager to increase estimates as markets moved higher from the Covid lows. At the beginning of each year, the estimate was increased to provide a larger pillow. Whether the targets are generated by estimating forward earnings per share and applying an average multiple to them, or by simply taking a year-end value and increasing it by 5-10%, these targets are poorly accurate and should carry little weight. should be taken into account when compiling a portfolio.
The implied return of the year-end forecast for current prices recently peaked at 26% – an attractive entry point based on the past 20 years. For all the folly of forecasters, an expected future return can seem tempting even to the most sophisticated investor. However, remember, predictions tend to follow the price and not the other way around.
At the start of the year, the difference between the high-end and low-end S&P 500 year-end target was 20%. As volatility increased and markets plummeted, bears turned significantly more bearish, but it wasn’t until July that the most bullish strategist lowered his target. The spread has widened considerably over the year, with a gap of no less than 50%. This introduces a significant amount of noise into the street’s consensus, which can make it more difficult for investors to determine the possible path.
We live in the information age: a bombardment of news, forecasts and opinions can affect how we make decisions. All too often we hear of exploding inboxes and the inability to simply keep up with the news.
The flow of information continues to grow. Consider the chart below, which simply charts the daily news stories about the S&P 500 on Bloomberg. Although a little erratic, the trend is clearly up and to the right. Social media is also increasingly dominating our time spent consuming information. the social The number of media stories for “stocks” peaked during the meme stock bubble in early 2021 and has since fallen, but interest is likely to pick up again during the next mania. The increasing amount of news makes it even more difficult for investors to find high-quality opinions backed by sound analysis.
Confirmation bias causes investors to seek out and evaluate information in a way that fits their current beliefs and biases. Essentially, it is the human tendency to pay more attention to information that supports your opinion and to ignore information and evidence that conflicts with the case.
As a media example, Fox News targets right-wing viewers with content that affirms their views. Likewise, the far left leans toward news sources that reinforce their views. Absorbing multiple media sources—those that agree with biases and those with opposing views—allows for a better holistic understanding.
Confirmation bias can narrow an investor’s focus and cause us to miss a major risk or change direction. It may also encourage investors to take on more concentration risk in an asset class, sector or position.
So, how can you defend yourself against bias? Force yourself to think about why an investment or strategy might not work (future hindsight). Think: what can go wrong with an investment? This makes you more open to seeing and considering opposing views and evidence.
Persuasive commentary on the markets is perhaps one of the biggest pitfalls for even the smartest investor. As Warren Buffet once said, “You can’t get rich with a weather vane.” Put in the work and do quality research yourself. Be wary of bold predictions and those who claim to know more about everything see what no one else sees. The best approach is to identify and combine knowledge from trusted experts with your own research and thinking. While this approach may be more challenging, it is much more rewarding.
At Richardson Wealth, we also emphasize the importance of continuous advice, tailored to your current portfolio. How often do you come across a helpful piece of research that recommends particular stocks or sectors? Without continuous advice and monitoring it is easy to keep going for too long. Create a solid plan to review current research and stay informed and rely less on point-in-time recommendations.
Source: Charts are from Bloomberg LP, Purpose Investments Inc. and Richardson Wealth, unless otherwise noted.