Predictions are difficult, especially about the future.
This famous quote came to mind from a recent survey of the track record of Wall Street research firms in projecting the longer-term returns of different asset classes. The quote is from Danish physicist Niels Bohr.
Those companies get a lot of press coverage when they update their forecasts, and they’re food for a lot of discussion. One such company is GMO, the Boston-based investment firm.
For example, according to the latest projections, US large-cap stocks are expected to see an annualized loss of 2.2% yoy in inflation-adjusted terms in the coming years. Emerging market equities, on the other hand, are expected to beat inflation by 8.5% yoy, while the inflation-adjusted yield of US bonds is expected to be minus 2.4% yoy. And so on.
I mention GMO because it has been way too bearish for US stocks for the past ten years. And the company has received its share of criticism and ridicule, although this year’s bear market has softened some of that criticism.
But according to a study just published, GMO isn’t the only one producing forecasts that don’t come close.
Titled “How Accurate Are Capital Market Assumptions and How Should We Use Them?”, the study was conducted by Mike Sebastian, an investment advisor who previously served as Chief Investment Officer at Aon (the British-American financial services firm), and NextCapital (the fintech company acquired by Goldman Sachs in August).
Sebastian came to his conclusion by compiling the expected returns of 17 companies’ asset classes in 2012, and then comparing those projections with what actually happened over the next decade. The results are summarized in the attached chart below.
Note that for 14 of the 15 asset classes Sebastian analyzed, the class’s actual 10-year returns were outside the minimum-maximum range of the companies in his sample. In other words, the asset class either delivered returns that exceeded even the most optimistic company’s projection for 2012, or worse than that of the most pessimistic company.
The only asset class for which 10-year actual yields fell within the minimum-maximum projected range (and even then barely) were non-US developed country stocks, whose true 10-year annualized yields of 6.2% were slightly better than the most pessimistic projection in 2012 of 6.0% yoy.
It would be easy to conclude that those results are devastating, and sobering to say the least. However, in an interview, Sebastian emphasized that capital market assumptions are not worthless. But his results show that they should not be taken as gospel.
A worthwhile approach he believes would be appropriate would be to seldom deviate from your standard asset allocation (your target weight for each of the asset classes) and not deviate very much when you do.
And on those rare occasions when you do deviate, you should only do so because you firmly believe that the Wall Street consensus is not only slightly inaccurate, but also vastly wrong. Premonitions of low belief are not sufficient reason. The average projections from different research firms, along with their minimum-maximum reach, would help us know what that consensus is.
The lesson here is not that you should find a better research firm than the prominent one in Sebastian’s sample. The analysts of those firms are some of the best and brightest people you will ever find in the investment arena, with impeccable educational and genuine backgrounds. And yet they are still sometimes wrong, and not just a little.
Humility is a virtue.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings keeps investment newsletters that pay a fixed fee to be audited. He can be reached at [email protected]