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US Stock Market Predictions & Stock Forecast

This article was originally published on UPFINA.

The post US Stock Market Predictions & Stock Forecast appeared first on UPFINA – Pursuit of Truth in Finance & Economics.

Will the stock market move higher or lower? This is one of the most commonly asked questions, and rightly so. However, the problem lies with the stock forecast itself. The simple truth is that no one person always has the right answer. They might have the answer some of the time, but not always.

The stock market is an aggregation of thousands of variables that each have varying impacts. To make it even more nuanced, you don’t always know if a certain variable is already priced into the stock market or not. Even if something is commonly known, that particular variable may not be priced in. In order to formulate even a remotely acceptable stock forecast, you need to understand macro economics. Macro economics has the highest bearing on how well the stock market as a whole and specific stocks will perform and whether or not your stock market prediction will be proven accurate.

Mainstream prognosticators rarely sway from the status quo of predicting 10% gains each year in the S&P 500. Put yourselves in the shoes of advisors who likely have most of their clients invested in the largest equity market in the world, the US stock market and stock market indexes such as the S&P 500, NASDAQ Composite and Dow Jones Industrial Average. Do you really want to scare them by predicting a decline? It’s in your best interest to predict at least a modest gain. You’re also playing the odds correctly by betting for positive returns. The S&P 500 on average outperforms inflation by 3% per year.

Stock Market Predictions

Stock market predictions are made more for media clicks and exposure than actual investing because each investor has different needs. This means that even if your thesis is that stocks move higher over the next two years, may not mean anything if the person will need this money sooner than that, perhaps in one year. Generally, prognosticators with a good reputation don’t want to make wild guesses. They prefer to cluster with other guesses. That way, even if they are wrong, everyone else was wrong, so they don’t look bad. You don’t want to be the only one to look bad. Only an advisor trying to make a name for himself/herself will take a shot at predicting a big gain or a big loss.

The quality of a stock market prediction can vary from to a shot in the dark to one that examines all pertinent variables and risks to come to the best probabilistic understanding of the outcome. As a result, you should always ask the question why, regardless of what the stock market prediction is. This will help you narrow down the weak points when the prognosticator gives you a poor argument to support their view. Additionally, what you should also be hesitant of is narratives. People like to listen to stories, but the world is a complex system. The truth, is rarely black or white. It is generally shades of brown and gray. The better the narrative, the greater the probability that corners were cut to reach it.

Best Stock Forecast

The point of this section is to fundamentally understand a stock forecast. Predictions, especially the ones made at the start of the year, should be mostly treated like entertainment. Obviously, if you hear a great argument backed by facts and plethora of supporting arguments, you should give it more credibility than other predictions. Hence, the reasoning behind the predictions is more important than the actual predictions. However, do not blindly follow someone’s understanding of the future because it might be totally unrelatable to your risk tolerance and time horizon for investment. Keep in mind that conviction in a market view is just as important to realizing positive portfolio results as the prediction itself. Just because a prediction may be right, does not mean that you would stick with it through the ups and the downs.

Another useful understanding of a stock forecast is that you can use them to gauge market sentiment. If the average stock market prediction is for a 5% gain, investors are bearish and if the average target is 15% higher, investors are bullish. These are probably top down predictions. A top down prediction is when someone reviews the macro economy to come up with a price target. A bottoms up prediction, on the other hand, uses individual company earnings estimates to determine a price target.

Where Is The Stock Market Headed?

The most important aspect to understanding where stocks are headed is realizing that earnings expectations are all that matter. This sounds simple, but sometimes negative headlines confuse beginners. The 2nd most important aspect is that the market works in percentages even though your mind might not. Rather than price in an event fully when it happens, the market usually prices in the odds of an event and then adjusts after it happens. This is expected value versus what actually occurs. For instance, say the market sees a 20% chance of a recession which could cause stocks to fall 30%. When the market goes from a 0% expectation to a 20% expectation, it will fall 6% to price that in because 0.2 times 0.3 is 0.06.  

It’s best not to be a constantly negative nor a constantly positive investor because markets are dynamic and the facts are always changing. The goal of this article is to help you find good fact based arguments. The S&P 500 index has a major positive catalyst which is that it removes companies that don’t meet its standards. It’s not fair to say the S&P 500 represents corporate America because it only represents the winners. This is why it’s difficult to match its performance. If you were to individually buy the 500 companies in the S&P 500 and hold them for 10 years, you would underperform the index.

Earnings Estimates Are Important

Predictions for equity returns are similar to how, outside of recessions, analysts start with forecasts of earnings per share (EPS) growth in the low double digits. If you see estimates for 2 years from now predicting 11% EPS growth, just ignore them. In the same way, ignore the fears of declining earnings estimates since estimates usually fall. If estimates started at 0%, declines would be a problem, but starting at above 10% sets the bar high especially if the comparisons are tough. Easy comparisons make double digit earnings growth easier to reach. Only during recessions do analysts come up with conservative earnings estimates which are usually surpassed. This is the case of recency bias. Analysts project the current economy onto the future. In recessions, estimates come down sharply.

The other notable aspect about earnings is estimates are usually beaten. Because estimates come down so much in recessions, they are beaten during them. That’s why the best measurement of earnings season isn’t the percentage of firms that have beaten results or how much the collective index has beaten estimates. Instead, the best measurement is the changes to future estimates which are based on guidance. It’s very common to see a stock crash on weak guidance even if the current quarter was solid. Sometimes firms are conservative with their guidance. Investors usually take this into consideration. The game is called UPOD, which means firms “under promise and over deliver”.

Next Stock Market Crash Prediction

Investors who are bearish on the stock market often claim that they don’t know why stocks are moving higher. Stocks in nominal terms usually move higher. That is the simple reality. The real question should be why stocks aren’t moving higher when they go down. It makes sense to be biased to the positive side when positive results usually occur. There’s a tendency for bearish investors to only read articles that support their negative biases. When they read a positive article, they mock it as impossible. Most bearish investors discuss the high leverage firms have without mentioning the earnings growth. They get agitated about how high valuations are without thinking about other methods of research which suggest stocks aren’t in a bubble territory. As we always say, the truth is generally in the middle.

Finally, bearish investors overemphasize the importance of the Fed, blaming the chairperson for every rally or fall. The reason for this blame is that they can’t entertain the possibility that their thesis is wrong. It’s an unhealthy habit to ignore when you’re wrong that can lead to consistently bad results. Consistently bearish investors fear a crash like 2008 coming again even though there may not be many indicators nor any immediate sign of one occurring. While valuations are high, it doesn’t mean they can’t become higher. You can always find data that suggest doom ahead, but it is just as important to realize that the combination of variables is more important than any one specific indicator.

Stock Market Forecast Next 6 Months

The stock markets react to changes in expected earnings. Understanding this critical point will help you formulate a more accurate stock market forecast for the next 3 or 6 months. The key is to forecast where future earnings estimates are headed. Earnings estimates generally fall, so you need to judge your opinion based on the average decline. If an earnings season causes next quarter estimates to fall 1%, but the average decline is 2%, it’s actually bullish.

When reviewing the stock market, you can either look at the fundamental factors effecting each sector and even look at the biggest companies individually or you can formulate an opinion on the macroeconomic economy and work from there. If you see estimates for 3% EPS growth even though comparisons are easy, and you are predicting a cyclical rebound, you should be positive on the market because estimates will increase or be beaten significantly. You also must review guidance and the changes to earnings estimates for individual firms. Half of a stock’s performance is impacted by its sector and half is impacted by its individual performance.

The key to finding a long term winning stock is finding a company with a defensible competitive advantage. One example of a competitive advantage is Apple’s ecosystem. Because its products and services are all integrated, once it has a customer, the customer’s switching costs increase. Apple is a unique company which has avoided having its consumer electronics becoming commodities like most other firms. It leveraged its brand to up-sell users on services after its iPhone sales growth slowed. This was a great pivot. It turned the iPhone into a cash cow once users started owning them longer before upgrading.

Conclusion

Accurately making stock market predictions and individual stock forecasts can give you an increased edge in markets. Stock earnings tend to start off optimistic regardless of the fundamentals. Anyone who consistently predicts outlandish declines or increases in stocks wants to generate media clicks. More importantly, these individuals probably don’t actually invest accordingly, or with a large percent of their portfolio, otherwise they would likely lose their entire investment. The velocity of the decline in earnings estimates determines if stocks should be bought or sold. Firms tend to under promise with their guidance and then over deliver. That’s why even in recessions, most companies beat earnings estimates. Hopefully, now you have a great starting point to understand stock market predictions and how you can accurately make a stock forecast yourself.

The post US Stock Market Predictions & Stock Forecast appeared first on UPFINA.

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