People continue to desert the bearish camp -- even some who correctly forecasted the 2008 collapse. They have lost their faith as equity markets have continued to push higher and some economic stats have shown signs of life. The less than resolute bears are now taking up residence with a cadre of “professionals” whose track record is poor -- fundamental analysts.
Fundamental analysts have a poor track record of predicting downturns, though it’s probably not a surprise to those reading this. Let’s face it: Since the stock market has mostly risen over the past 75 years, it has paid to be bullish. As a result, there is an imbedded bullish bias in the analyst community. Here are two good examples:
Example #1. Standard & Poor’s just released an updated forecast of $74.55 of operating earnings for the benchmark S&P 500 in 2010. How bullish is that? Well, 2006 saw the all-time high for operating earnings at $87.72. So, even though frugality is now in vogue, the saving rate is rising and credit is difficult to come by, S&P would have us believe that operations at the 500 largest public companies will be just 15% under all-time record levels next year! This forecast is laughable, yet many people believe it.
To assign the correct weight to S&P's current forecast, let's take a quick look at its analysts' record in predicting the 2008-2009 earnings collapse. Back in March 2007, S&P’s analysts’ estimate for 2008 was $92; the actual figure came in at $49.51, meaning that their estimate was 46% too high! In March 2008, with the recession already underway, their estimate for 2009 was $81.52. But, with half the year complete, that estimate has now been decreased to $55.25. Those facts don’t lend much credibility to their 2010 estimate. As the tables reveal, their estimates simply followed equity prices down. (Tables from: "Thoughts From the Frontline" by John Mauldin).
Since stocks bottomed in March of 2009, estimates are now on the rise again, but these forecasts are worse than useless for forecasting the actual price performance of the S&P 500. This is because the analysts who create these forecasts are subject to the same psychological pressures that create Elliott waves in the first place. Analysts tend to extrapolate trends rather than anticipate turns. In other words, they herd -- just like most investors. This leads them to be overly optimistic at tops and overly pessimistic at bottoms.
Example #2. S&P isn’t the only organization becoming more bullish. As the S&P 500 broke through the 940 level, a major Wall St. investment house raised its year-end target for the index from 940 to 1060. That forecast would have been more helpful if it had been produced in early July when the S&P 500 was trading near 870 (let alone back in Feb/Mar when EWI's Bob Prechter in his Elliott Wave Theorist suggested a target for the rally of 1000-1100). But, since their forecast is based on fundamentals, which lag market prices, only now do the fundamentals warrant higher prices, according to the firm.
Numerous well-respected forecasters are also turning less bearish on equities because they believe that the lows have been seen. Still others believe that the recession will end late this year thanks to the aggressive fiscal action and the Fed’s “money printing.” By the top of this bear market rally in equities (that we've labeled "Primary-degree wave 2") many people will begin to wonder if new lows will ever be seen. This is exactly how it was in April 1930, March 1974 and March 2002...
Far from shying away from our long-term bearish forecast, we continue to suggest that there’s a great “flight from risk” trade coming. EWI will continue to focus on market prices to determine our forecasts, both bullish and bearish, which actually have some predictive ability -- unlike so many fundamental analysts' forecasts.
A chance reading of a book on technical analysis and the Austrian school of economics eventually led Jason Farkas, CMT, to Elliott Wave International. Prior to joining EWI Jason worked for 14 years as a futures, options and equity trader. Jason has been tutored by some of the best investment minds, including legendary trader Dick Diamond. You can read his Weekly Insights every Friday in EWI's intensive Currency and Interest Rates Specialty Services. Or, send him your feedback now.