by I sometimes poke fun at short-term forecasts. It’s not that I don’t believe in making forecasts (we all have to do that). It’s just that I find it a little silly to try to forecast short-term stock market moves because the stock market is an inherently long-term instrument (the stock market has at least a decade+ duration depending on how you calculate it).¹ Forecasting the monthly or annual changes in stocks is like looking at a one year 2% yielding bond and trying to forecast the ten day moves to generate more than 2% from it. This is an instrument that is designed to provide its 2% returns over a certain period of time. No matter how impatient you are we can’t all make a 2% yielding one year bond yield more than that. In fact, in the aggregate, the more we trade the lower we
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I sometimes poke fun at short-term forecasts. It’s not that I don’t believe in making forecasts (we all have to do that). It’s just that I find it a little silly to try to forecast short-term stock market moves because the stock market is an inherently long-term instrument (the stock market has at least a decade+ duration depending on how you calculate it).¹
Forecasting the monthly or annual changes in stocks is like looking at a one year 2% yielding bond and trying to forecast the ten day moves to generate more than 2% from it. This is an instrument that is designed to provide its 2% returns over a certain period of time. No matter how impatient you are we can’t all make a 2% yielding one year bond yield more than that. In fact, in the aggregate, the more we trade the lower we guarantee the total return will be.
This is why, when we’re putting together forecasts it’s important to put the time horizons in the proper perspective. And while the majority of Wall Street likes to put together useless short-term forecasts there’s one firm that seems to do forecasting fairly well – Vanguard. For instance, I recently posted Vanguard’s latest market outlook to Twitter:
Vanguard ten-year projected return ranges: U.S. equities: 4.0%–6.0% U.S. aggregate bonds: 2.5%–4.5% International equities: 7.5%–9.5% International bonds (hedged): 2.0%–4.0%
Most of the responses were something along the lines of “same as always”. Except that’s not true at all. If you go back and look at Vanguard’s 2009 & 2010 market outlooks they were quite a bit more optimistic with expected ten year US equity returns of 8-12%.
Now, Vanguard doesn’t disclose how they generate this model, but it appears to be some version of a valuation based model. So, given where broad valuations are it’s not surprising that Vanguard is less optimistic than usual since high valuations tend to coincide with lower future ten year returns. But the key takeaway is that Vanguard doesn’t play the annual forecasting game. They are specifically providing a TEN YEAR outlook across a range of probable outcomes.
Will Vanguard be right?
Of course, the more important and interesting question is, will Vanguard be right? That’s impossible to know. While using a more long-term model increases the likelihood of being more accurate the range of outcomes is still uncertain. That said, there are some good lessons from the way Vanguard operates here:
- We all have to make forecasts when projecting our future return needs.
- Using a forecasting model that better aligns with the time horizon of the actual instruments will improve the probability of accuracy.
- Short-termism kills.
¹ – Why do people do this? In short, people are impatient and Wall Street’s salespeople are often incentivized to try to take advantage of our impatience.