In the wake of oil’s recent plunge, analysts’ new favorite pastime seems to be attempting to pinpoint the bottom. These types of short-term, myopic forecasts are a loser’s game—no one (to our knowledge) can actually identify the very bottom or top for commodities, stocks or anything else with any repeated precision.[i] Yet this has never stopped sell-side research analysts from issuing recommendations with a price target, a practice that is largely noise distracting investors from more important market trends.
Not all investment analysts are the same—in fact, there are two major categories in the industry. Buy-side analysts, who work largely for money managers or funds and analyze with the intent to guide investment decisions the fund or firm may actually make. And sell-side analysts, who tend to work for brokerage houses. The latter are probably best known for rating stocks, setting and adjusting price targets and the like. They slap a buy/sell/hold rating on it and tell you how high or low they think it’ll go. Which sounds like very actionable help!
Price targeting provides what we’d call an “aura of precision”—something that has the appearance of real, hard analysis, but is actually just a guess. Consider: In this industry, you’re a legend if you forecast broad market direction right about 60%-65% of the time. What’s the likelihood an analyst nails a specific price? And are many investors, media types or others actually keeping score? For example, we found few articles weighing the simple fact few oil analysts calling a bottom now forecasted oil’s recent fall. So how useful are these new targets anyway? It’s plain and simple—no one holds a crystal ball. But this is the way the business operates the world over. We aren’t hating the player, we’re hating the game.[ii]
But before you can assess accuracy, some definitions are needed: What does it even mean to be right? Once the price target is met, analysts often set a new one! Was their target right or wrong? Anyone? Bueller? So it’s an endless, fruitless cycle—a cycle that long-term investors would be better off ignoring. What if you took their first target as gospel and pressed sell when it got there?
For starters, it’s near impossible to pinpoint when a security will drop to X price or what that X price may be! It’s a coin toss as to whether you or the analysts get it right. There isn’t anyone we’re aware of who can really hit the top or bottom—of a bull or bear, a correction, or an individual security’s movement—with repeat precision. Sure, analysts’ predictions are on mark at times—heck, a broken clock is right twice a day, and in bull markets, most stocks overall rise. But even if they are right, sell-side analysts’ forecasts tend to be very short-term and myopic—not especially helpful for investors in the long run. It isn’t all that relevant to your long-term return whether you hit the exact top or bottom.
You could be forgiven for thinking sell-side analysis—ratings and price targets—is pretty much marketing spin, attempting to trigger all sorts of emotions. They get your green monster riled up with a big lofty price target and an ambitious “buy” rating (or “strong buy” or “accumulate” or “conviction buy”). A “sell[iii],” “downgrade” or price target cut plays to fear of a free fall.
The result is investors heeding the “advice” generate commissions as they buy, sell, or buy with conviction. That highlights the fact brokerage houses have an inherent conflict of interest since many of them serve as intermediaries and benefit from investors buying or selling the same security. Therefore, it remains to be seen if buy actually means, you know, buy. Conviction buy is equally odd, only with an airy multisyllabic word in front designed to make you think they really, really mean it. But the conflict of interest implies whatever they rate the security, what they mean is just, “Transact.” We aren’t suggesting all sell-side research is flawed, but rather, there are some pretty big caveats we think investors should weigh when relying on it. The bullet-pointed recommendation and price target are flashy, but the least valuable part of basically any analysis. However, they are often the nexus of discussion whenever this subject comes up in the media, which could lead you astray. That should also be your sign these targets are widely known information, which means (ironically) price targets are priced.
Taking action based on these iffy, very short-term forecasts could lead to investing errors (and missed opportunity). But also, it seems to us the whole practice revolves around short-term market timing and stock picking, which emphasize what we believe aren’t very meaningful inputs in your longer-term return.
We think it’s much more fruitful to focus on factors affecting the market’s likeliest trajectory over the medium to longer term—since you probably need your portfolio to last far beyond a day, week or several months. To do this, we’d suggest looking at three broad market drivers—political, economic and sentiment. (Exhibit 1) Politics and economics are two fundamental drivers. Some factors investors should consider: Does government gridlock exist? Is the yield spread widening or narrowing? Is the Conference Board’s Leading Economic Index falling or rising? And sentiment helps to identify if those drivers are appreciated or not. Are investors so pessimistic anything but the worst case scenario would be a plus? Do they think the rare positive factor will soon morph into a negative, and highlight all of the “yah, buts” in an overall positive data reading—skeptical? Are they accepting of rosy news—optimistic? Or are they overly enthusiastic about crummy news—euphoric?
Exhibit 1: Portfolio Drivers
Source: Our craniums, Fisher Investments Research.
Any portfolio strategy should start by identifying a longer-term asset allocation likely to reach your goals. Then, we believe it’s apt to analyze the three drivers to help investors determine a market forecast with this question in mind: Is a bear market likely forming? If not, then determine sector, country, size and style decisions, remembering that no one category is permanently superior. Lastly, select securities based on the category emphasis you elected. This has its own set of considerations, to be sure, like liquidity, the company’s solvency, strategic attributes (is the brand strong?) and any oddities you can’t explain on the balance sheet. All these and more matter, but in our view, price targets or ratings don’t.
Folks, you are free to choose which brand of analysis you prefer. It’s a free country, you know. But you really shouldn’t paint all equity and market analysis with the same broad brush. Some of it is just sales spin.
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[i] Without a great deal of hindsight, that is. Anyone can identify a top or bottom a year after the fact.
[ii] Meeeeeeeeeeeeeeeeeeeeeeh. We are surprised we did it, too.