Those of you who know us know that there’s only one way to be right at least once in a while when making predictions… and that’s to make loads of predictions! But even when we are right, it can be for the wrong reasons. And that was partly the case in 2022. You will also see, in this short letter, that since the beginning of the century, forecasting has been erratic, to say the least. Just for fun, we will throw in our two cents at the end.
On the whole, for 2022, analysts’ forecasts for U.S. corporate earnings were almost spot on. However, when broken down by sector, the predictions were off, sometimes by a wide margin. For the consumer discretionary sector, for instance, they were 23% too high; for communications, 16% too high. But for energy, the reality was 100% higher than forecast. In short, overall, very accurate, but for the wrong reasons.
As well, predicting the level a stock market index will reach a year in advance implies that many variables must be predicted all at once. Analysts have been right (overall) about corporate earnings, but have underestimated the impact and magnitude of rising interest rates and inflation. The result: a much lower price/earnings ratio in 2022, which dropped from almost 25 to about 19. Thus, we are now only paying 19 times the earnings instead of 25, which has caused the stock market to pull back, even though current earnings were as expected.
So how have stock market predictions for the coming year fared since the turn of the century? Out of 23 years, the average estimate has been accurate to + or – 5% only seven times; predictions have been much too high nine times and much too low seven times. Of course, some individuals manage to predict everything with great accuracy. Nevertheless, it is impossible to identify them in advance. After all, thousands of analysts and economists flood us with forecasts and predictions. It’s a bit like the lottery: we know that someone will win, but we don’t know who until the draw.
So how do you manage your portfolio? Predicting the stock market remains a rather pointless exercise. It’s a bit like predicting the weather: we all look at the forecasts even though we know that there’s bound to be a slip-up somewhere!
History is a tool that can help us see the future because although history does not repeat itself, it often rhymes. Looking at the past, when a strong correction is triggered, its length very often depends on whether it is followed by a recession or not. If no recession occurs, the correction usually lasts about 12 months. If a recession happens, the correction usually lasts around 24 months. We know a recession will eventually occur, but will it be in 2023 or later?
The current correction started in November 2021. So, if no recession occurs, we should be through the worst of it. If there is a recession in 2023, we should expect a bumpy first half of the year. But does it really matter? We don’t think so. When investing in the stock market, we should plan on staying invested for at least five to 10 years. Finding properly valued companies that will make it through a recession is much more important than whether or not we still have a few months of stock market fluctuations left. The goal of portfolio management is to maximize long-term returns and minimize sleepless nights. If you have trouble sleeping, you can increase your cash holdings to a maximum of 40%. Otherwise, stick to 5% to 15% and take advantage of opportunities as they arise. The first few months of the new year are likely to be turbulent for the stock market.
From all of us here at Claret, all the best for 2023.
—Jean-Paul Giacometti, for the Claret Team