- Forecasts are extremely positive, but know that a bear market or a recession are never in the picture.
- Of all the S&P 500 ratings, 49% are Buy ratings, 45% are Hold ratings, and 6% are Sell ratings.
- Be sure to understand the risks of what you’re doing and know history. It may not repeat itself but it rhymes.
Similarly to what analysts do, policy makers are also usually very positive about future economic developments. We could say that positivity is in their job descriptions.
Analysts mostly work for banks or investment companies that make more money if markets go up and people invest more. Policy makers aren’t allowed to be negative as any negative comments can push an economy into negative territory sooner than it would naturally do so.
What’s important to understand is that analysts and policy makers are very bad at predicting recessions. The red circle below shows how analysts didn’t see the financial crisis coming and forecasted linear earnings growth in 2007 and 2008.
Analysts are always optimistic with their forecasts – 1year forecasts vs. actual
In this article, we’ll review analysts’ and the FED’s forecasts for 2017 to give you a good base for understanding the risks and possible rewards going into 2017.
The current estimated S&P 500 earnings growth rate for Q4 2016 is 3% which is possible as oil and commodity prices have rebounded. However, to show you how overly positive analysts usually are, the estimated growth for Q4 2016 back in September was a staggering 5.4%.
It’s extremely important for the S&P to grow earnings as earnings have been almost flat in the last two years while stock prices have increased in the same time period on future growth expectations. If earnings don’t grow, then stocks will inevitably revert to the mean.
S&P 500 Change in forward 12-month EPS vs. change in price
A sector perspective on earnings shows that utilities, financials, and IT are going to be the best performers while real estate, energy, industrials, and telecom services are expected to negatively weigh on earnings.
The extreme differences between earnings growth among sectors reiterates the fact that 2017 should be another excellent trading year, as 2016 was, due to high sector volatility. You can read more on how to rebalance and trade in 2017 in our article available here.
Another significant influence on earnings will be the dollar. If the FED continues to tighten, we could see a stronger dollar which will impact the earnings of companies with international revenues, mostly IT, materials, and energy.
Aggregate S&P 500 sector geographic revenue exposure.
Speaking of the FED, let’s have a look at what the FED expects by analyzing the latest meeting minutes. The FED slightly increased its real GDP growth forecast on the assumption that fiscal policy would be more expansionary in the coming years and consequently, expecting an even lower unemployment rate and slightly higher inflation. However, the FED also mentions some risks to this outlook in the form of shocks from abroad, the stronger dollar, higher inflation, changes in the tax, spending, and regulatory mix, etc.
January 2008 Federal Reserve Governors and Reserve Bank Presidents’ projections.
The clear conclusion is that neither analysts nor the FED will predict the next recession or bull market. I find it hard to believe that they can’t predict it and lean more toward the theory that they are not allowed to predict a recession due to job constrictions and policy implications.
The result of positive policy forecasts and earnings analyses are extremely positive ratings and targets. Of the S&P 500, 49% are Buy ratings, 45% are Hold ratings, and only 6% are Sell ratings.
The aggregate of average targets would lead the S&P 500 to a level of 2,456.39. The above figure also shows how targets are always above current levels because analysts always look at the rearview mirror to predict the future.
As investors, we shouldn’t try to predict the future as neither the FED nor bank analysts can do it with all of the data and brainpower at their disposal. Similarly, we can’t expect to predict aggregate S&P 500 earnings as most aggregate analysts’ estimations are slightly wrong if things go well and completely wrong if there is a recession around the corner.
What we can do is analyze what would happen to the stocks we own in a positive, neutral, and negative scenario, and attach probabilities to the relevant outcomes and calculate the risks and rewards of our portfolio. Analysts’ and policy makers focus mostly on positive scenarios and outcomes, but that isn’t how the economy works. The economy works in cycles whether we like it or not.
The main message of this article is to clearly assess the risks the current stock market has and plot them against your investing or retirement goals. To me personally, the above positivity rhymes too well with 1999 and 2007. Therefore, I have positioned myself so that I have plenty of cash in order to buy on the cheap if a recession comes along and also to be exposed to the upside if the bull market continues by selecting stocks that are undervalued and have positive catalysts no matter what the market does.
What I still don’t understand is the 95% buy and hold attitude that has taken over the markets. It usually doesn’t end well. Let me end with a quote: “If you’re at a poker table and you don’t see a sucker, it’s you.”