«The same procedure as every year, James». For those not in the know,
the quote is from a short 18-minute comedy sketch Dinner for One, which
is shown on German-language TV every year on 31 December.
Every year in December, analysts also make forecasts for the coming year.
Blind man’s bluff approach beats analysts
The best analysts of Wall Street’s most prestigious investment banks publish their forecasts for the US stock market S&P 500 on an annual basis. They are some of the highest paid employees at Morgan Stanley, UBS, Goldman Sachs and JPMorgan Chase. However, these brilliant minds are unable to even come close to predicting the actual development. Quite the opposite – they fall short of the real stock market performance with great regularity.
The forecasts of these highly paid analysts are even worse than if a forecast of 9% were assumed each year, which corresponds to the long-term average of the S&P 500 performance since 2000.
Evaluations of the star analysts’ forecasts show that their predictions are off the mark by 14.7% p.a. on average. The regular forecast of 9% per year is slightly better at 14.1%. Even if we were to exclude the particularly poor year of 2008 from this analysis, the analysts would still be behind the «blind» forecast of 9%.
Interestingly, the analysts’ predictions for every year were positive; no market declines were forecast. It also seems that the corrections for 2000-2002 did not have any impact on the following year’s forecasts. A recovery was predicted every year following a correction. It was always assumed that the market would recover again.
In the media and among many banks and investors, predictions occupy a very important place without the added value of proven forecasts.
On the contrary, it seems as if forecasts lead to false conclusions and rarely reflect true development. On the basis of scientific findings, much caution should be exercised with forecasts. The fact that many investors still value forecasts so highly probably has more to do with psychological factors than with rational factors.
Can we forecast currencies?
A similar picture can be seen in currency forecasts. Various studies show that it is virtually impossible to predict currency trends. A study by the University of Würzburg (Bofinger/Schmidt 2003) concludes that currency forecasts may often be as much as 180 degrees away from the real development.
Currencies have a great influence on the return of a securities portfolio. If we consider currencies to be an asset class like shares, bonds, etc, we see a very large contribution from currencies to the returns and risks of investment strategies.
How can we therefore deal with currencies as an investor?
Essentially, there are three options:
1. Consistent hedging of currencies against the domestic currency.
2. Consistent «non-hedging» of the currency and acceptance of currency variations.
3. Adjustment of the investment strategy depending on the currency forecast.