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Investors shouldn't expect market predictions to be right on the nose. Some strategists have not only a standard prediction but also ones for best-case and worst-case scenarios. But in forecasting, you've got to set the bar somewhere. Take
weather forecasts. One easybut very roughway to guess this Monday's weather would be to look at Dec. 23rds of the past. In New
York's Central Park, that day on average has been a chilly 35 degrees and seen 0.13 inches of precipitation, according to National Weather Service data from 1981 to 2010. Of course, forecasters try to do better by using powerful computers to analyze weather patterns. If over time all that computing power doesn't result in a better forecast, we all might as well shut down the computers and rely on those averages. Stocks,
for their part, have historical price changes for the S&P 500. Stock strategists use complex models to try to be more accurate, but if that brain power doesn't result in a more accurate forecast, we might as
well stick to historical returns. Since 2000, strategists have failed to meet that low bar. Say
that at the end of each year, you found the median annual change in the
S&P 500 since 1929 and used that as your guess for the next year's price change. For example, in 2006, your guess would have been 9.06% the median price change between 1929 and 2005. That method would have beaten the strategists half the time since 2000, according to a Wall Street Journal analysis. "It
doesn't give you any positive evidence that analysts are providing added information," says Brad Barber,
a finance professor at the University of California, Davis, who has researched the value of analyst recommendations and earnings forecasts. To be sure, Mr. Barber says that we'd need a larger sample size to prove definitively that strategists' forecasts don't have any value. So what's the problem? For
one, since 2000 the strategists as a group have never forecast a drop in stocks. The upward bias makes some sense; stocks have risen in 55 of 85 years going back to 1929. But the optimism could also reflect Wall Street's tendency to be forgiving of bullish strategists who end up being wrong, says Citigroup's Mr. Levkovich. He says a Wall Street friend once gave him some advice: "If you're a bull and you're wrong, you're forgiven. If you're a bull and you're right, they love you. If you're a bear and you're right, you're respected. If you're a bear and you're wrong, you're fired." Mr. Levkovich, who
thinks the S&P will rise to 1900 next year, says that he would make
a negative forecast if the circumstances warranted it. But the larger issue might be simpler: Forecasting the stock market accurately is extremely difficult, if not impossible, says Masako Darrough,
an accounting professor at Baruch College who has researched biases in analysts' earnings forecasts.
Rather
than invest more or less in stocks based on strategist calls, she says most investors are better off sticking with their usual allocations and,
for planning purposes, to assume that stocks over the long run will rise at their usual pace. Since 1926, large-company stocks have had an average annual total return of 9.8% including dividends, according to Ibbotson Associates. Cut strategists who must make projections some slack, but don't bet on their accuracy either. Email: joe.light@wsj.com
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