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 Failed Forecasts 

A significant part of our investment philosophy lies in the reality that it is not possible for people - even 'experts' - to predict movements in investment markets.  Therefore we have included this page on 'failed forecasts' to show this reality in action.

From our Blog Sunday, 13 July 2008

The Not so Hot Stock Picks from December 2007

 

Last week I wrote a blog identifying some less than impressive stock picking for the 2007-08 financial year.  This week I have come across another example of how stock picking just does not work.

 

A Daily Telegraph article published December 15th 2007 provided what they phrased the "hottest" stocks for 2008 according to six leading analysts - Craig James (Commsec), Rick Klusman (Aequs Securities), an analyst from Merrill Lynch, Peter Switzer (Switzer Financial Services), an analyst from Fat Prophets & an analyst from Credit Suisse.  (The hot stocks of 2008)  Each analyst chose between 4 & 5 stocks. 

 

The returns (including dividends) from the close of trade on the 14th of December to the close of trade on Friday (11th July) are set out below.  The ASX200 returned negative -23.29% for the same period (not including dividends).

 

Craig James

Rick Klusman

Merrill Lynch

Peter Switzer

Fat Prophets

Credit Suisse

Code

Change

Code

Change

Code

Change

Code

Change

Code

Change

Code

Change

RIO

-7.51%

BXB

-30.43%

NWS

-37.09%

WBC

-32.03%

COK

41.27%

TWR

-20.42%

GNC

-24.35%

SNV

-52.63%

BSL

15.61%

BHP

-3.28%

MUN

-34.18%

ILU

-1.81%

LEI

-26.42%

REX

-48.02%

AWC

-24.64%

BNB

-72.72%

IMA

-57.98%

RRT

-92.75%

HVN

-55.76%

CCP

-82.40%

MQG

-34.32%

OXR

-40.79%

CXC

-46.84%

ZFX

-37.86%

CSL

-3.57%

SRA

-25.00%

BBP

-70.91%

DES

-81.48%

 

 

PEM

-76.69%

Average

-23.52%

 

-47.70%

 

-30.27%

 

-46.06%

 

-24.43%

 

-45.91%

vs ASX200

-0.24%

 

-24.41%

 

-6.98%

 

-22.77%

 

-1.14%

 

-22.62%

 

The performances of these picks are less than appealing with every picker's average performance below the ASX200 index.  The average under performance for all 29 shares was 13.03%.  If you had started with $100,000 you would now be left with $63,685 not including transaction costs.  (Keep in mind that the ASX200 result does not include dividends over the period.  This makes the actual result even worse.)

 

Now of course it has only been 7 months since the picks were made.  Some of these picks may turn into extremely good investments in the long term.  (Our preferred approach is to buy and hold for the long term.)  However, given the brief given to the pickers to identify the hot stocks for 2008, not the long term, the record speaks for itself.

 

So what is the alternative to stock picking?

 

The approach to building investment portfolios taken at A Clear Direction Financial Planning is based on scientific research around the realities of how market works.  We use index funds as the core of the growth component of a portfolio and then tilt portfolios towards the higher risk, higher expected return sectors of equity markets - namely small and value companies as well as emerging markets in the international context.

 

Take a look at our Building Portfolios and Research based Approach pages on our website for more details.

 

Regards,

Scott Keefer

From our Blog Monday, 7 July 2008
2007-08 Expert forecasters do worse than chance

 

Now that the investment books for the 2007-08 financial year are closed it is worth having a look at some of the forecasts and predictions made at the beginning of the financial year to see how they turned out.  The Sunday Mail ran a piece over the weekend - Redemption time - Stock experts shrug off a painful year of investing.

 

The article looked at the 5 stock picks by four experts at the beginning of the 2007-08 year:

 

Tony Dennis

Tim Lincoln

Joel Palmer

Joseph Kingsley

Director, equities

ABN Amro Morgans

MD, Lincoln Intelligent Sharemarket Solutions

Principal Palmer Portfolios

Client adviser

Wilson HTM

Code

Change

Code

Change

Code

Change

Code

Change

BHP

+24.8%

BHP

+24.8%

MND

-8.2%

MQG

-42.6%

TOL

-58.2%

MND

-8.2%

WTP

-66.6%

BHP

+24.8%

ORG

+64.3%

CSL

-59.1%

SUL

-44.7%

SDM

-17.3%

DOW

-6.3%

TOX

-35.7%

MLI

-60.9%

NWS

-39.2%

MQG

-42.6%

MRM

-18.4%

MCR

-28.4%

PXS

-54.1%

Average

-3.6%

-19.32%

-41.76%

-25.68%

Out-performance

12.94%

-2.78%

-25.22%

-9.14%

 

To put these results in context, the ASX200 Index returned -16.54% over the year (not including dividends).  The average performance across the 4 experts was -22.59% or 6.05% below the ASX200.  Well done to Tony Dennis for beating the market but based on pure chance you would expect two of the four to have out-performed and two to have underperformed so basically the group as a whole did worse than pure chance.

 

An index fund would have to have had fees and costs of 6.05%to have matched the performance.  (Vanguard's Australian Share Index Fund has a fee of 0.75% on the first $50,000 or 0.34% for wholesale investors)

 

I know where I would have preferred to have my hard earned money invested.

 

Regards,

Scott Keefer

From our Blog Tuesday, 6 November 2007
Forecasting the Aussie Dollar - Analysts Get It Wrong
 

As financial planners who recommend the use of Dimensional funds we have access to regular articles written by Jim Parker, a Regional Director at Dimensional Funds Australia.  In his most recent article Jim looks at the rise of the Australian dollar and looked back at what analysts were predicting at the beginning of the year.

 

Jim reports that according to a Reuters poll of currency analysts with the major domestic and international banks conducted in January, it was predicted that the Australian dollar would be around 78 cents by July and 76 cents by early 2008.  The current exchange rate of the Australia dollar places it at 22% above these levels.

 

This finding yet again shows the failure of forecasting.  These analysts are paid to make these forecasts but more often than not they get it wrong and not just by a small margin.

 

Some current predictions see the $A reaching parity with the $US.  Given the recent history of predictions would you feel comfortable relying on their predictions?

 

The clear lesson to be learnt is that nobody really knows how exchange rates nor equity markets will be into the future.  Trying to make or follow predictions is fraught with pitfalls.

 

Regards,

 

Scott Keefer

__________________________________________________________________

Summary from Jim Parker's article - Fundamental or Technical - The Future is Unknown - Published October 2007

 

Jim Parker has looked at company forecasts that underlie the decisions made by fundamental analysts in determining whether the market is correctly valuing a company.  Jim finds that according to new global research by KPMG, more than three quarters of companies admit to forecasting errors of more than 5 % in critical areas such as supply and demand, sales growth and financial estimates.  Only 1% of 539 companies could say that that they provided completely accurate forecasts.

 

So what does this mean for the average investor?

 

Jim concludes that forming a portfolio based on fundamental forecasts for individual companies is futile and the best estimate of the value of a firm is the current price.  He finishes by pointing out that prices can certainly be wrong from time to time - there is no reliable way to tell how they are wrong (either too high or too low).  The best course of action is to structure portfolios around known sources of risk and return.  Higher expected returns are available from stocks over bonds, from small company over large company stocks and from lower-priced 'value' stocks over higher-priced 'growth' stocks.

__________________________________________________________________
 

Summary from Jim Parker's article - The Dangers of a Narrow Forecast

Published October 2007

 

In this article Jim Parker looks at the Business Review Weekly's front page story at the beginning of 2006 - ?The Top 25 Stocks for 2006'.  In their article BRW claimed that the 25 companies were well positioned no matter which way the market moved in 2006.  The list included a number of blue-chip names, including Brambles Industries, Cochlear, Lend Lease, St George Bank and Wesfarmers and resource stocks, particularly energy-related companies, were well represented.

 

Jim looked at the results of these companies and compared them with the market average.  Altogether BRW's portfolio would have delivered a return of over 14% in 2006.  The S&P ASX200 accumulation index returned just under 22% for the same period.

 

Jim's article highlights yet again that an investor would have been better placed focusing on investment fundamentals of risk and return rather than pursuing active management positions.

 
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From our Blog Monday, 18 June 2007
If at first you don't succeed: Forecast, Forecast and Forecast again   

About 3 years ago - mid 2004 - there was a brave forecast circulating in the media by economists BIS Shrapnel, which forecast interest reserve bank interest rates to hit 8%.  This would have made mortgage borrowing rates somewhere around 9.5%.  Pretty scary stuff. 

Here is the exact text from a Melbourne Age article dated the 14th of August 2004, from the article entitled 'Interest Rates - How High Will They Go':

'On the bear side is BIS Shrapnel, which is forecasting interest rates to peak by late 2006, with the Reserve Bank's cash rates hitting about 8 per cent. That's an extra 3 1/4 percentage points, or $550 a month, on a $225,000 home loan.'

Not suprisingly this report led to various doom and gloom forecasts for property prices - if interest rates were going to rise that far, then property prices would have to fall sharply.  (Or as a mate of mine says, property prices don't fall, they just consolidate).

Not long after this BIS changed their forecast, as mentioned by Australia's best financial commentator in this expert from the Sydney Morning Herald about 12 months later.

Alan Kohler, Sydney Morning Herald, 28 September 2005

The other item in the news this week was BIS Shrapnel's prediction of 6.5 per cent interest rates next year because of rising inflation. This firm had previously forecast interest rates of 9 per cent next year, so it was interesting that the media reporting of its latest report did not say: "BIS Shrapnel cuts rate forecast."

And now I see that BIS have jumped back onto the media forecasting wagon again, and are forecasting 22% growth in Brisbane property prices over the next three years - a much happier situation than previous forecasts would suggest.  The interest rates forecast to go with this is a 1/4 of a percent rise by September this year, and then interest rates on hold.

The bottom line is this.  Economic variables are tough to forecast - just look at BIS Shrapnel - in 2004 they tried to forecast 2 years ahead and missed by a lot, in 2005 they tried to forecast again and were out by half a percent.  Finally, having predicted in 2004 higher interest rates which would have had a negative impact on the property market, in 2007 they predict above average property growth in Brisbane.

Now, if you can just chop and change forecasts at a whim, I have an idea.  Why can't you have more than one forecast on the go at any one time?  So I am going to have a go at this forecasting game, and predict that over the next 12 months:

  • Australian Shares will be down by 5%
  • Australian Shares will return 0%
  • Australian Shares will return 5%
  • Australian Shares will return 10%
  • Australian Shares will return 15%
  • Australian Shares wil return 20%
  • Australian Shares will return 25%

It's a slightly different tact, but who else out there is guarateed of being able to point to the correct forecast in 12 months time!

__________________________________________________________________

16th May 2007 - Extract from our Quarterly Directions Newsletter

An article in the Australian Financial Review - Australia's Premier Financial Newspaper - ran an article in June last year (2006) entitled, 'Brace Yourself, the Bull Run is Over Say Technical Experts'.  The article forecast that 'By March next year, the S&P 200 index should get around the 4,000 mark'.

 

That forecast was ridiculously wrong.  The S&P 200 index was actually more than 6,000 points during March this year - 50% higher than the failed forecast!  If you believed the forecast at the time, which was that markets would drop by 20% in the next 9 months, you would have sold all your Australian share holdings.  If you had done that, you would have paid capital gains tax when you sold, missed out on a return of 20%, and would be out of the market - an absolute disaster.

__________________________________________________________________

2nd May 2007 - Failed (or revised) Forecasts

A big part of our investment focus is around the fact that you cannot manage to forecast what is going to happen in the markets.  Therefore we tend to keep an eye out for evidence of our opinion.  This is not hard - there is a fair bit of it out there.

Take this article from the Australian Newspaper on the 2nd of May.  It was talking about JP Morgan - one of the big financial service firms in Australia - and their forecast that the Australian stockmarket would be trading at a level of 5,930 points by the end of the year.  With the index now trading at 6,240 JP Morgan have decided that there forecast was wrong.

Of course, they don't jump up and down and say this.  They just 'revise' the forecast - up by almost 10% to 6,520 points. 

Is a forecast that is wrong by almost 10% 4 months into a year really all that useful?

Keep an eye out for failed forecasts.  They are all around us.  And don't be too swayed by them.

One important way of dealing with the lack of skill in forecasting is to carefully think about the asset allocation of portfolios.  Next week's e-mail update (Financial Fortnight that Was) will look at using asset allocation to build successful investment porfolios.  Please click here to subscribe!

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29th December 2006 - 'Tis the Season of Financial Porn

'Tis the season of Financial Pornography.  By financial pornography I mean the short of highly speculative, highly exciting, short term financial predictions that dominate the media at this time of the year.  It is important to understand that predictions simply don't work.  To demonstrate the folly of trying to make short term predictions, and invest according to these predictions, I have included evidence from four different sources.

 

Exhibit A: ABC Midday News Forecasts.  The ABC had a number of experts make predictions for the Australian stock exchange for the year of 2006.  The predictions for the ending value of the Australian stock exchange ranged from 4,400 points to 5,200 points.  The Australian stock market ended the year at 5,670 points (ASX 200 index).  The closest forecaster was more than 9% away from the actual result.  Hardly a forecast, more of a guess, I would suggest.

 

Exhibit B: Australian Financial Review.  The Australian Financial Review is Australia's pre-eminent financial newspaper, by some margin.  In June this year Tim Findlay ran an article entitled, 'Brace Yourself, the Bull Run is Over, say Technical Experts'.  The crux of the story was an interview with a 'Professional Technical Trader and Chief Executive of Market Newsletter Alter Trader'.  His forecasts were for markets to fall to 4,000 points after reaching a maximum of 5,250 in June.  Clearly he was wrong. 

 

Exhibit C: Australian Fund Managers Forecasting 2007.  Straight from a financial pornography article are this year's forecasts from four experts who manage money for a living.  The forecasts vary so much, that one of them is bound to be correct, with the other wrong.  The forecasts range from optimistic 'Strong 2007' to pessimistic 'Tougher Year' with a bit of moderation 'Strong 2007 with a Bit of Caution' thrown in.  Clearly there is no consensus forecast.  This also shows the problems with forecasting - get enough forecasts and someone is bound to be right just through dumb luck!

 

Exhibit D: The Most Famous Failed Forecast of 'The Death of Equities'.  In 1979 Business Week, a US publication, was amongst the most famous financial publications.  They made the extraordinary claim that equities (shares) were no longer a relevant investment.  Before looking at the article, let's take a peak at the ending.  Since 1979 US shares have experienced an unprecedented boom.  Even the market collapse of 1987 and 2001 could not stop this from being a period of well above average returns from the US stockmarket.  It was a great time to own US shares.  However, at the start of this period Business Week had said that share ownership was dead.  Here are some quotes from the article:

 

"Further, this "death of equity" can no longer be seen as something a stock market rally--however strong--will check.  It has persisted for more than 10 years through market rallies, business cycles, recession, recoveries, and booms.

 

The problem is not merely that there are 7 million fewer shareholders than there were in 1970.  Younger investors [Baby Boomers?], in particular, are avoiding stocks.  Between 1970 and 1975, the number of investors declined in every age group but one: individuals 65 and older.  While the number of investors under 65 dropped by about 25%, the number of investors over 65 jumped by more than 30%.  Only the elderly who have not understood the changes in the nation's financial markets, or who are unable to adjust to them, are sticking with stocks."

 

The simple reality of how markets work is that we cannot forecast market movements. Therefore this should not be part of our investment strategy.  Instead, the focus must be on building a sensible asset allocation, exposing a portfolio to a variety of asset classes - and stick with it in the long term.  And don't get distracted by worthless  financial porn.

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18th September 2006 - The Folly of Forecasting   

Trying to forecast market movements is fraught with danger.  There is overwhelming evidence, academic and otherwise, that predicting market movements simply cannot be done.

As an example, a recent Eureka Report edition focused on the expected returns from the Australian sharemarket.  The Eureka Report is an online magazine that I have a lot of respect for, and am a regular contributor to.  The headlines were as follows:

  • Charlie Aitken:  It's just Chicken Little . and another September buying opportunity
  • Patrick O'Leary: The ASX will be flat through 2007, and the sky might actually fall.

      The US fund manager: If there's no US recession, stocks will rally 25%.

      Shane Oliver: The savings glut is about to return ? that's good for shares.

  •  

    There is a wide diversity of opinion there, from the sky is falling to a possible 25% return.  One of the problems with forecasts is that one of them is likely to be right, and we tend to assume that is by skill and not luck.  However, if there were 50 different opinions then one is likely to be correct, and the owner of that opinion will suddenly assume guru status - although dumb luck suggests some people have to get a forecast correct!

     

    How do we incorporate these forecasts into investment portfolios?  Simple - we don't try to forecast returns.  The long run returns from growth assets - Australian shares, international shares and listed property trusts have all been around 12-13% a year.  So exposing ourselves in a diversified way to all three asset classes will provide sound long term returns - without the hassel of worrying about short term forecasting, or the cost and tax inefficiency of buying and selling to chase forecasts.

    Scott Francis' articles in the Eureka Report 

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