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Why Wall Street’s number crunchers have more conviction in their forecasts
“In economic parlance, the current environment is one of pervasive ‘Knightian uncertainty’ — that is, an unknown for which we cannot even quantify the odds of various outcomes.”
That’s what JPMorgan economist Michael Feroli wrote in mid-March as massive parts of the economy were suddenly shutting down in an effort to contain the rapid spread of the coronavirus. In the span of a few days, Feroli and his economist peers revised their estimates for GDP from moderate growth to outright collapse, making “guesstimates” along the way as the circumstances were totally unprecedented and timely data was limited.
Similarly, Wall Street’s stock market strategists were flying blind as the forecasting environment was made worse by corporate execs suspending or withdrawing their widely-followed guidance, leaving everyone in the dark. The strategists nevertheless hacked their forecasts (only to learn that they cut by too much).
Some — like Canaccord’s Tony Dwyer, Oppenheimer’s, John Stoltzfus and BMO’s Brian Belski — went as far as to suspend their S&P 500 (^GSPC) targets.
Much of this has since changed. We are no longer peering into a blackhole of uncertainty where it appeared tail risks could come to a head. Uncertainty has returned to a much more manageable level.
With about five months worth of data — including a full earnings season — and the COVID-19 pandemic not getting much worse, Wall Street’s number crunchers now have much more conviction in their analyses and forecasts.
And with the new information, they’re realizing they overshot on the bearish side. Just on Friday after the better-than-expected personal income and spending report, JPMorgan and Goldman Sachs economists hiked their Q3 GDP annualized growth tracking estimates to +27.5% and +30%, respectively, from +20.0% and +26.5%.
Also on Friday, BMO’s Belski reinstated his year-end S&P price target at 3,650, further adding that he sees the index climbing to 3,850 in the next 12 months.*
Coping with the evolving uncertainty backdrop
While Belski felt emboldened enough to publish forecasts about the stock market, he nevertheless cautioned against relying too much on conventional valuation metrics, many of which appear stretched.
And so in the same way economists are paying closer attention to unconventional real-time metrics like OpenTable restaurant activity and Homebase hourly worker data, Belski argues stock market investors should be mindful of bullish forces that are next-to impossible to forecast.
“From our lens, it is precisely the resourcefulness of US companies, let alone society itself, to adapt and improvise – a ‘pivot’ that does not easily show up in a quant screen, macro model, or valuation metric,” he wrote. “Bear markets and recessions create despair, and from despair comes hope. Part of that hope with respect to stock market performance is new leaders, new concepts, and new themes.”
He continued: “we believe it is extremely difficult in the current environment to employ a market forecast ruled by traditional academic variables. Yes, risk premiums, risk-free rates, earnings growth, and valuation metrics are not as meaningful over the intermediate term as process-driven strategists like ourselves would prefer.“
So yeah, there’s still plenty of uncertainty out there.
But the point of this discussion is to acknowledge that the degree of uncertainty we face now is nowhere near the levels we saw back in March.
Furthermore, this isn’t affecting behavior in just the Wall Street analyst community.
Companies are engaging the capital markets, businesses are ramping up durable goods orders, and consumers are buying houses. Everyone is increasing their wagers as uncertainty returns to manageable levels.
