Wall Street's dirty secret: It's terrible at forecasting stocks

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New York CNN  — 

December is a month full of market predictions for the year to come. Everyone, from economists to analysts to grocers, seems to have a strong feeling about how stocks will behave going forward.

Here’s the thing: They’re almost always wrong.

What’s happening: Last year, Goldman Sachs analysts predicted that the S&P 500 would close out 2022 at 5,100 points. Morgan Stanley predicted a more bearish 4,400. The S&P 500 closed on Tuesday at 3,829.

No major analysts predicted last December that this year would (likely) be the worst for US stocks since 2008, that oil prices would shoot from $70 to $130 and then careen back to $70, and that the Federal Reserve would announce four straight historic three-quarter point interest rate hikes.

Geopolitical chaos, global pandemics and extreme weather events have created unexpected and outsized head and tailwinds – creating extremely turbulent rides for markets.

“As they take stock of this year, investors should strike a certain sense of humility as they peer into next,” wrote Christopher Smart, chief global strategist at Barings in a recent note. “They may take some consolation that outside US intelligence circles, almost no one expected a Russian invasion last December. But that will be small consolation amid difficult markets and evanescent returns.”

Most analysts seem to expect that inflation risks will subside next year, leading the economy into a light recession and eventual recovery – but they’re still asking investors to wear their seatbelts at all times, in case of any unexpected bumps along the way.

With those caveats, let’s get to Wall Street’s predictions

The numbers: Forecasts for where the S&P 500 will finish 2023 vary greatly. Below is a roundup of estimates made by five major banks, reported in notes and year-end reports. You can see that they’re largely hovering around 4,000. (Note: these predictions are subject to change).

  • Barclays: 3,725
  • Citi: 3,900
  • Bank of America: 4,000
  • Goldman Sachs: 4,000
  • JPMorgan: 4,200

The bottom line: Take these predictions with a grain of salt.

Over the previous 20 years (2002 – 2021), the average difference between the target price estimates by industry insiders at the beginning of the year and the final price for the index for that same year has been 8.3%, according to a FactSet report.

Analysts overestimated the final value (that is, the final value finished below the estimate) in 13 of the 20 years and underestimated the final value (the final value finished above the estimate) in the other 7 years.

This year, forecasters are set to miss the mark by their widest margin in about 15 years, according to FactSet data. They’re on track to have overestimated the performance of the S&P 500 in 2022 by nearly 40%.

Market analysts are great at explaining what drives stocks in the short-term, but predictions clearly haven’t been their cup of tea – nor should they really matter to investors. The S&P 500 has good years and bad years, but long-term investors know that it typically works out in the end: The return averages out to about 10% per year for nearly the last century.

It’s been a very bad year for markets, but investors have been holding out hope for a year-end boom that would send stocks upward into the new year. Now it appears that Santa Claus won’t be coming to town, after all.

What’s happening: Markets often surge at the end of the year – one last gift for investors during a time when market volume and volatility is relatively quiet.

Technically, the “official” time frame for a Santa Claus rally is the week of trading between Christmas and New Year’s Day, but analysts believe it’s unlikely that Saint Nick will reward investors with a nice, big rally to end the year.

During this period, the S&P 500 has historically gained 1.3% on average, according to data from LPL Financial going back to 1950. The average return for all rolling seven day periods is just 0.2%.

Trading activity is often low Christmas week, as institutional investors take time off. This gives more opportunities for retail investors, who swing bullish, to sway markets. Bonuses and holiday gifts also provide additional cash to invest in the stock market.

If the S&P 500 finishes higher during this year’s Santa Claus rally, it would mark the seventh consecutive period of positive returns during the final week of the year.

Lump of coal: Just a short time ago, it looked like Santa was coming early this year when the S&P 500 rallied 14% over the course of four weeks. Then on Friday, the beginning of that seven day Santa Stretch, markets closed higher – with the S&P 500 gaining 0.6%.

But Tuesday, traders received a lump of coal. Wall Street ended lower at the beginning of the holiday-shortened week.

It’s important to look at fundamentals and valuations before getting all wound up with holiday cheer, said Scott Wren, senior global market strategist at Wells Fargo. “That might sound like Ebineezer Scrooge, but sometimes all of that cheer needs a shot of reality along with the eggnog and this may be one of those times,” he said.

Rate hikes will continue, he said, and the economy will likely stumble in the coming months along with markets. “Santa Claus is coming to town, but we believe it is unlikely he will reward investors with a big equity rally to end 2022.”

China-related stocks surged after Beijing took a major step in reopening its economy this week.

Beijijng will drop quarantine requirements for international travelers beginning on January 8. Those changes come after nearly three years of isolating and painful restrictions.

Chinese companies that trade on the Nasdaq were some of Tuesday’s top performers. JD.com and Baidu gained more than 4%. The Golden Dragon China Index, which tracks Chinese companies on American exchanges, rose about 2%.

Inbound travelers will only be required to show a negative Covid test result obtained within 48 hours before departure, China’s National Health Commission (NHC) said in an announcement late on Monday. Currently, they are subject to five days of hotel quarantine and three days of self-isolation at home, report my colleagues Yong Xiong, Xiaofei Xu and Nectar Gan.

Restrictions on airlines over the number of international flights and passenger capacity will also be removed, according to the announcement.

China has sealed its borders since March 2020 to prevent the spread of the virus, keeping itself in global isolation even as the rest of the world reopened and moved on from the pandemic.

Foreigners have been largely banned from entering China, apart from a limited number of business or family visits. The NHC said it will further “optimize” arrangements for foreigners to visit China for work, business, study or family reasons and “provide convenience” for their visa applications.

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