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Who called it right -- and wrong -- in 2002
With few exceptions, the calls made by analysts and strategists a year ago are a steaming pile of forecasting failure. Here's why, and what we can learn.
By Michael Brush
As 2002 winds down, youre going to be dazzled by market pundits peering into their crystal balls to forecast the best investments for next year.
While their clairvoyance will seem compelling, a look at last years prophecies shows only one thing is certain about these forecasts: Many of them will be dead wrong.
To give you a fighting chance in finding the few gems as you navigate this years crop of fearless forecasts, we took a look at some of the best and worst calls of last year. Our goal was to glean the lessons that will help you spot the true insights -- and dodge the doggies. Heres your guide:
Those authoritative Wall Street pundits will once again predict juicy gains, but take it all with a grain of salt. As much money as high-profile stock market strategists like Goldman Sachs' Abby Joseph Cohen or Prudentials Edward Yardeni earn, youd think they might have called the down market this year.
Not so.
Like most strategists -- who as a group predicted gains of 12% in 2002 for the Standard & Poor's 500 index -- they were way off. Instead, the S&P 500 looks like it will close down by more than 20%. Two years ago, just about all the Wall Street pundits made the exact same mistake.
Why do so many market forecasters throughout the investment community consistently get it wrong by shooting too high? I dont think they are wrong, because I dont think they believe their own bull, says John LaForge, a money manager at the Phoenix-Hollister fund family in Sarasota, Fla. I think they are forced to say these things because their business is investment banking, not research. You cant go to a client and say, The market is going to decline 20% next year, lets go public.
The lesson in all this? Recognize that Wall Street has an agenda which is not in your interest, because they want to keep selling deals, says Damon Vickers, an outspoken radio talk show host who publishes an investment newsletter called the Short Report.
In fairness, not all sell-side strategists got it wrong. Richard Bernstein and Steven Milunovich, of Merrill Lynch, consistently warned investors of overcapacity and rich valuations, especially in tech land.
And market strategists on the buy side made bad forecasts for this year, too. About 85% of money managers expected either single- or double-digit returns.
One of the few who stood out for his vocal bearish forecast was Ken Fisher of Fisher Investments. All that market bluster at the start of 2002 reminded him of a drunkard trying to keep a party going -- the stock market bubble -- even though its time to head home. Unfortunately, Fisher turned bullish at the wrong time in the late spring, just as the market was about to move into steep declines. For the record, Fisher now says hes wildly bullish about 2003, predicting 35% gains in the broad indices.
Put the most faith in what you hear from independent research firms. By now, most people realize that the sell-side analysts at Wall Street brokerage houses are suspect because they work alongside investment bankers. Since the bankers bring in the big bucks, the reasoning goes, these analysts color their work to help sell the stock created in the banking deals.
A little number crunching by Hoboken, N.J.-based Investars.com -- which tracks analysts ratings -- bears this out. Investars.com follows the work of about 115 sell-side shops and 20 independent research outfits out of the 400 or so stock research groups in the country from both camps. Of the top 10 performing stock portfolios last year, no fewer than seven were cooked up by independent research shops, the ones with no investment banking ties.
They best of the best were: Parenteau Corp., Avalon Research Group, Analytiq Group, Standard & Poor's, RDEX Research, Canaccord Capital and Global Capital Institute. Sell-side shops on the top 10 list were: Sandler O'Neill, Hoefer & Arnett and SBI USA.
And the worst 10 portfolios?
You guessed it. Its dominated by sell-side shops. The worst-performing portfolios were concocted by CE Unterberg, Pacific Growth Equities, Soundview Technology, Adams, Harkness & Hill, Punk Ziegel & Co. and Janco Research.
Pretty compelling evidence, no? But it gets better. A look at last years best and worst individual stock picks makes the exact same case. The best calls were made by Callard Asset Management and Global Capital Institute, which nailed the outlook on the ill-fated cable company Adelphia Communications (ABIZQ, news, msgs), now in bankruptcy. (I wish Id listened to them; in a year-ender column for 2001, I suggested Adelphia stock looked cheap based on revenue and profit estimates.) Standard & Poors put in a strong showing with prescient calls on UAL Corp. (UAL, news, msgs), the parent of United Airlines, and i2 Technologies (ITWO, news, msgs).
Only one sell-side shop makes an appearance on this top 10 list. Morgan Stanley was consistently ahead of the moves in the shares of Ericsson (ERICY, news, msgs). To be sure, many sell-side analysts who did not make the top 10 list deserve an honorable mention. Prudential Securities banking analyst Mike Mayo, for example, gets kudos for sticking his neck out and forecasting problems that eventually battered shares of major banks like Citibank (C, news, msgs) and J.P. Morgan Chase (JPM, news, msgs).
Astonishingly, the worst 20 calls last year (on stocks which still had a rating in the past six months) were all made by sell-side shops, according to Investars.com. Bear Stearns had the lousiest record, for its consistently bad calls on Rural Cellular (RCCC, news, msgs). But US Bancorp Piper Jaffray, Prudential Securities, Friedman Billings Ramsey and Credit Lyonnaise also round out the bottom of this list.
It cant go that much lower is one bad reason to buy a stock -- even if it is already down 90%. After former tech high fliers like Nortel Networks (NT, news, msgs), Lucent Technologies (LU, news, msgs), JDS Uniphase (JDSU, news, msgs) and Sun Microsystems (SUNW, news, msgs) had fallen 70% to 90% from their highs by the start of 2002, many sell-side brokerages like Goldman Sachs and SG Cowen Securities were touting them as compelling buys. The reason? They looked cheap. Too bad for anyone who followed their advice: All these stocks proceeded to fall another 70% to 90%.
Ouch!
How did investors get suckered into making such big mistakes with these bubble-market darlings? Again, you can chalk it up to the positive bias of the sell side. But others fault the mindless buy the dip mentality that gripped many who refused to admit that tech is a cyclical sector that still plagued by too much capacity in many segments.
Other lessons? How high a stock traded in the past means nothing, says Pat Dorsey, the director of stock research at Morningstar. In short, when the big selling points in the forecasts you see is that a stock is down so much, dont walk away -- run.
Be skeptical of corporate managers. One of the worst calls many investors made last year was to ignore the warning signal that came from Enron when the extensive fraud finally came out. There was plenty of time to reduce equity holdings before widespread allegations of wrongdoing at companies as varied as WorldCom (WCOEQ, news, msgs), Tyco International (TYC, news, msgs), Adelphia and HealthSouth (HRC, news, msgs) helped drive stocks down to panic lows in July.
Why did we complacently deny that more nasty fraud allegations were on the way? Because the scale of these things was so outrageous, says Roger McNamee, a partner at the technology investment firm Integral Capital Partners in Menlo Park, Calif. I dont think it ever occurred to anybody that people would behave so badly.
Another problem was simply putting too much faith in management. There was this flawed mentality that management was on our side because they were compensated with stock in their own companies, says LaForge. It turned out to not be the case. Everyone is out for themselves.
Scott Cleland, chief of the Precursor Group, an independent Washington, D.C., stock research firm, blames a lack of advocates for the investor. And hes not sure things have changed much. If investors and regulators are too trusting, they will get burned again, he says. Unless the economy improves enough to allow companies not yet caught to mask past accounting frauds, more are probably going to come out. One hedge fund manager with returns in the 80% range for each of the past two years is convinced another major bankruptcy is coming soon.
History may offer little guidance. One axiom trotted out by market cheerleaders last year was the notion that the stock market had never gone down three years in a row in recent history. So how could it happen now? That was one of the worst calls, all these people talking about history being so important, says Terry Bedford, a money manager at Bedford and Associates Research Group in Hamilton, Ontario.
Indeed, many of the old rules dont seem to apply anymore, says James Paulsen, an economist and market strategist with Wells Capital Management. For years, for example, investors successfully followed this rule of thumb: Go long stocks whenever the Federal Reserve cuts interest rates three times. No more. Its also a little creepy to have zero job growth even though the economy expanded by 3% this year. And never before have we seen retail sales grow so much -- by volume -- even as prices drop. The whole year was full of surprises, says Paulsen. Clearly times are different, and you should be skeptical of forecasters still putting blind faith in the old historic rules.
Beware of trendy investment ideas. Twelve months ago, domestic security stocks such as OSI Systems (OSIS, news, msgs), InVision Technologies (INVN, news, msgs) and Cepheid (CPHD, news, msgs) -- which make baggage screening devices and anthrax tests -- were all the rage because terrorism dominated the front pages. These stocks will no doubt move up if there is another terror strike. But if you had followed the crowd and bought them a year ago, you would be losing money today.
Use the press as a contrarian indicator. Being on the phone with money managers and traders all day makes the financial press an accurate market mirror. As you monitor forecast coverage this month (including plenty of it on MSN Money), look for signs of emotional extremes.
One fairly safe bet: you can trade against emotional extremes that make it onto magazine covers, once you learn how to read them right. Just before the lows in early October, The Economist magazine's cover was adorned with a photo of a forlorn ship stranded at sea; next to it was the headline: Doldrums. The world economy and how to rescue it. A few weeks later, Business Week's cover story was The Painful Truth About Profits. The painful truth was that prospects for profit growth were bleak. Market indices advanced sharply following those covers, though they have pulled back since.
Long-time market observers swear its no coincidence that emotional extremes in the media coincide with market extremes. When the press becomes overly bearish, says Michael Painchaud, research director of Market Profile Theorems in Seattle, when everything becomes very monotonic negative in the press, my ears perk up.
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