“Predictions Are Difficult…Especially When They Are About The Future” – Niels Bohr
We can't predict the future – if it were possible fortune tellers would all win the lottery. They don't, we can't and we aren't going to try to. However, we can analyze what has happened in the past, weed through the noise of the present and try to discern the possible outcomes of the future.
The biggest single problem with Wall Street, both today and in the past, is that they consistently disregard the possibility for unexpected, random events. In a 2010 study, by the McKinsey Group, they found that analysts have been persistently overly optimistic for 25 years. During that 25 year time frame Wall Street analysts pegged earnings growth at 10-12% a year when in reality earnings grew at 6% which, as we have discussed in the past, is the growth rate of the economy. Ed Yardeni published the two following charts which show that analysts are always overly optimistic in their estimates.
This is why using forward earnings estimates as a valuation metric is so incredibly flawed – as the estimates are always overly optimistic. Furthermore, the reason that earnings only grew at 6% over the last 25 years is because the companies that make up the stock market are a reflection of real economic growth. Stocks cannot outgrow the economy in the long term…remember that.
However, as we enter into the 5th year of the decade what do the decennial trends tell us about the probabilities of stock market returns in the coming year.
In reviewing 2014, we find that the 4th year of the decade has been positively biased over its history turning in an average return of 5.42%. However, the positive return years have outnumbered the negative by 12 to 6.
As shown, 2015 is extremely “bullishly” biased. The average annual return in the 5th year of the decade is a monstrous 21.47%. The 5th year of the decade has a history of large double-digit returns.
The win/loss ratio equates to an 83% probability of further gains in the coming year.
While statistics suggests that 2015 leans more heavily towards positive returns, there is sufficient cause for concern. Before you go piling into equities, it should be noted that there are only THREE (3) previous periods where all three prior years were positive return years. One of those three periods returned a -8.5%.
