When forecasting equity markets, throw caution to the wind

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Jim McDonald said anyone trying to predict the markets should 'go high or low.'

Forecasts typically are cautious, going for average, and wind up outside the range of actual outcomes.

The typical S&P 500 forecast tends to be about the least likely to turn out to be accurate, according to an 87-year analysis by Jim McDonald, senior vice president and chief investment strategist, Northern Trust Asset Management, Chicago.

“Most strategists' annual forecasts fall in a range of 10% to 15%,” Mr. McDonald writes in an NTAM 2014 outlook report, released Dec. 19. But “the actual return has only fallen in that range 7% of the time historically” based on calendar years since 1926.

Only the zero-to-5% range of returns has occurred less frequently, at 6% of the time.

All the other ranges of returns have occurred more frequently in a distribution that “exhibits very fat tails,” Mr. McDonald writes.

The two most frequent sets of returns are any return less than zero, or negative returns, which have occurred 28% of the time, and returns above 25%, occurring 26% of the time.

In between, returns ranging from 5% to 10% occurred 10% of the time; from 15% to 20%, 13% of the time; and from 20% to 25%, 10% of the time.

Over the 87 years, the average annual return of the S&P 500 is 11.8%.

“If you are going to guess, go high or low!” Mr. McDonald concludes.

This article originally appeared in the December 23, 2013 print issue as, "When forecasting equity markets, throw caution to the wind".