At year’s end, many analysts make market predictions for the next twelve months. The S&P 500® index is a popular target for such forecasts since it is commonly used as a market proxy and its constituent stocks are widely followed. Hence the bottom-up analysis — a sum of estimates for all individual equities makes an index forecast.
Who better to predict the S&P 500® index level than the S&P itself? Let’s take a closer look at their forecast accuracy. The following chart compares the predicted to actual values of the index, which Alpholio™ compiled from historical editions of S&P Capital IQ’s The Outlook:
To be exact, these 12-month targets were typically set in early to mid December of the preceding year, while the actual index values were recorded on the last trading day of the predicted year. Also, dividends were not taken into account in this price index.
The immediate takeaway from this chart is that the forecast for 2008 vastly overestimated the actual price: 1,650 vs. 903, or by about 83%! The financial crisis and its magnitude caught everyone, including members of the S&P Capital IQ’s Investment Policy Committee, by surprise. Excluding that outlier year, here are the index prediction and annual return statistics:
|Statistic||Prediction vs. Actual||Actual Index Return|
The sample is admittedly small, under ten data points. But a trend is emerging — on average, S&P predictions underestimated the actual index. This tendency is further illustrated by the following chart from FactSet’s Targets & Ratings report:
The chart shows how a bottom-up target price (dashed line) moved almost in parallel with the actual index (solid line) in the 12 months through October. In other words, predictions were adjusted upwards with a lag as it became evident that original estimates were likely going to be soon surpassed. (As a side observation, almost half the stocks in the S&P 500® were rated a Buy, slightly less than half a Hold, and only about 5% a Sell. Even a booming market, a less optimistic distribution would be intuitively expected.)
S&P offers another interesting prediction for the next year:
We also believe 2014 could be one of those years in which the S&P 500 is up for the entire year but suffers through a pullback of 5%-10% (and more likely a correction of 10%-20%) before ending the year higher than where it started. One reason is that 26 months have elapsed without the S&P 500 slipping into a correction, versus the average of 18 months (and median of 12 months) between declines of 10% or more since 1945.
If statistically the market is overdue for a correction, let’s also hope that by the same token S&P underestimated the 500® index’s value in 12 months from now. In that case, we should be expecting a price of about 1930 instead of the current target of 1895, while keeping in mind that perfect market predictions are virtually impossible.