By David Larrabee, CFA
For the better part of the last three decades, investors have looked forward to reading investment strategist Byron Wien’s “Ten Surprises” at the beginning of each year. The annual Barron’s Roundtable, the well-known forecasting forum, is another long-standing January tradition. Both are generally considered to be interesting and thought-provoking, if not always accurate, predictions of what is in store for investors during the upcoming year. Barron’s and Wien, who joined Blackstone in 2009, are still at it, and their forecasts remain entertaining reading, but these days they have plenty of company.
Most leading brokerage houses and many prominent investors have joined in, compelled to issue their own versions of a Top 10 list. Indeed, issuing a list of your favorite stocks or investment themes for the year ahead now seems almost obligatory for any self-respecting strategist or money manager. A press release or a television appearance touting your picks is low-cost, yet effective, marketing. And there seems to be an eager audience: forecast-related gatherings are among the most well-attended events at the CFA Institute local societies each year. All of which, of course, has meant more noise for investors. As we approach the saturation point, it is worth pondering whether these forecasts merit the attention of professional investors.
How well do the forecasters do in their predictions? Well, the record appears mixed at best. A generous assessment of Wien’s 2011 predictions shows a success rate of 50%, much better than his 20% showing in 2010. Wien isn’t alone in his struggles to accurately forecast the future. It’s almost a certainty that every public prognosticator will eventually be humbled if he stays in the game long enough. PIMCO’s Bill Gross famously bet against Treasury bonds at the start of 2011, only to acknowledge it was a mistake in August. Undeterred, Wien recently issued his Ten Surprises for 2012, and Gross published his investment outlook for 2012. While Wien and Gross are well-established success stories, there is no denying that a good call or two can make a career, which probably explains, at least to the cynics, why so many are willing to go out on a limb. But are clients well served by such bravura? A 1995 study by Hemang Desai and Prem C. Jain examined the performance of common stock recommendations at Barron’s Roundtable from 1968 to 1991, and found the excess returns to be essentially zero for the one- to three-year postpublication day holding periods.
Despite being of dubious value, market forecasts are understandably popular. Professional investors are receptive because they are always looking for the next great idea, particularly at the start of a new year when the performance slate is wiped clean. And if a stock is included in someone’s Top 10 list, the herding instinct of most investors will often prod them to buy the stock for fear of missing out. Conversely, the contrarian may look to these lists for stocks to avoid or short. Wall Street Journal columnist Jason Zweig, who has written extensively on investors’ propensity to herd, explored the utility of market forecasts in this 2011 article.
Investors’ short attention spans may also offer a partial explanation for the popularity of Top 10 lists — they are easy to digest. But they also often lack rigorous, supportive analysis. Importantly, the CFA Institute Code of Ethics calls for its members to “use reasonable care and exercise independent professional judgment when conducting investment analysis.” Further, the CFA Institute Standards of Professional Conduct requires members to “have a reasonable and adequate basis, supported by appropriate research and investigation, for any analysis, recommendation, or action.” This is not to say that an idea cannot originate from a Top 10 list, only that independent analysis and judgment are also required.
Market forecasts and Top 10 lists are probably here to stay. They have proven themselves to be a useful marketing tool for Wall Street salespeople from both the buy side and the sell side. But while a Top 10 list may be the perfect vehicle for Wall Street and comedian David Letterman, investors should consider them with caution. The job of the professional investor is to sift through the noise and make independent and informed judgments that are in the best interests of his clients. As for those who pursue the folly of forecasting, they would do best to heed the advice of economist Edgar R. Fiedler who said, “If you have to forecast, forecast often.”