In the last two days there have been two rather spectacular predictions about the market. While I am working on my own 2011 preview, I interrupt my regularly scheduled programming to consider the forecasts from these respected sources.
Two Extreme Viewpoints
There was breaking news yesterday about Yale Professor Robert Shiller's most recent market forecast. He revealed his projected S&P 500 forecast for 2020: 1430 Yes, you heard that right. Ten years from now -- virtually no gain from current levels -- an annualized growth rate of 1.3%. This is an amazing call in an era when markets often exceed that percentage change in a single day, and when so-called "bullish strategists" are calling for a 10% market gain on the year. Essentially, it is a forecast for a flat market.
If you believe Shiller, you should not invest in stocks -- or real estate, since he also does not like that sector.
In sharp contrast, there was also breaking news today from Laszlo Birinyi, who also made a big forecast. He sees the S&P 500 at 2854 by 2013. This is much greater than the most bullish mainstream estimates.
What a difference! At the time I am writing this, there is quite a difference in market coverage. Seeking Alpha (where I am one of the original contributors) is typical. There is no story on Birinyi, while Shiller is still a front-page feature, with supporting opinions wondering whether he might be too optimistic. Wow! There is also no featured article even suggesting that Shiller might be a touch too bearish. This is such a dramatic difference between the two that it deservers a more thoughtful evaulation.
My Take
I do not agree with either forecast, and I have good reasons.
Shiller. I start with a bias. I like professors, I respect Yale, and I am impressed by Professor Shiller -- both his work and his personal appearances. I am therefore surprised that I cannot find more useful advice from his analysis. Here are three key points:
- No one has ever made any money in real time by following Shiller, including Shiller. He got out of the market in 1997. I invite comment from anyone who has a track record of successful real-time trading based upon the Shiller method.
- Shiller's approach does not successfully predict next year's earnings, the most interesting data for nearly every stock analyst and market forecaster. I have an open challenge to anyone to show that Shiller's backward looking method is better than the one-year forward estimates by analysts at predicting next year's earnings. This is a simple factual challenge with no takers so far.
- Shiller's approach almost never signals a buy. Maybe if interest rates get to 20% again we will see the P/E ratio's in the single digits that his backtesting shows to be a good time to have made a (theoretical) stock purchase.
To summarize: The Shiller method provides no real guidance for investors.
Birinyi. The Birinyi approach looks at history and measures various cycles and time frames. As I have frequently noted, there are not enough cycles to make such determinations, and circumstances have changed too much for such comparisons. Instead, let us examine the Birinyi prediction in a different way. After adjusting the assumptions a bit, let us consider the following:
- We will look at forward estimates of operating earnings (OK with me, but viewed as too bullish by many).
- We will start with S&P earnings of $100 for 2011 (very optimistic according to most).
- Let us apply earnings growth of 15% per year for three years, bringing us to earnings of $152 in 2014. (This is also an estimate well beyond most expectations).
- Let us suppose that the P/E multiple expands to 15. Oops, not enough. 16? Try again. It takes a multiple of 19 to reach the Birinyi target. There have been multiples of 19 in the past, especially with very low interest rates, but it is not something that most would expect.
To summarize, the Birinyi target and time frame seem far too optimistic. To be fair, I wonder why this approach is given less credibility than Prechter (Dow 1000?) or Shiller. Readers interested in an actual analysis of past predictions should check out the Guru grades at CXO Advisory. (Prechter 24%, Birinyi 51%).
The wise investor is aware of two things:
- The long-term market trend in earnings and in price, and
- His own needs and risk tolerance.
