Richard Fisher, who’s currently the President and Chief Executive Officer of the Federal Reserve Bank of Dallas, once gave a speech in November 2009 talking about the American economy and his insights about its future. In it, he mentioned a particularly interesting story about the Nobel Prize-winning economist Kenneth Arrow. Arrow served in the US. Army Air Corps during World War II and helped analyse weather forecasts that were made for months into the future. He eventually found that these forecasts were next to useless and tried to warn the generals in the military. The response he got, however,…
Richard Fisher, who’s currently the President and Chief Executive Officer of the Federal Reserve Bank of Dallas, once gave a speech in November 2009 talking about the American economy and his insights about its future.
In it, he mentioned a particularly interesting story about the Nobel Prize-winning economist Kenneth Arrow. Arrow served in the US. Army Air Corps during World War II and helped analyse weather forecasts that were made for months into the future. He eventually found that these forecasts were next to useless and tried to warn the generals in the military. The response he got, however, would likely elicit a wry chuckle from you as you marvel at it. In Arrow’s own words:
“The commanding general is well aware that the forecasts are no good. However, he needs them for planning purposes.”
Sure, laugh at it if you will. But this is the level of senselessness that I think permeates the financial markets, especially when it comes to America. Take for instance, the following data I pulled from a recent Wall Street Journal article titled “For S&P 500, Strategists’ Forecasts Fall Short”:
|Year||Average strategist forecast for S&P 500 (estimated) made at the start of the year||Actual S&P 500 gain|
Source: Estimated from afore-mentioned Wall Street Journal article
The figures came from the average forecasts of Wall Street (America’s financial centre) market strategists that are tracked by investment firm Birinyi Associates. It’s easy to see the stark difference – without me pointing out the obvious – between the forecasts and the actual return of the S&P 500, a broad American share market index.
Given such a track record and the fact that the strategists are still in business, it leads me to believe (and I might be wrong here) that what we’re seeing in the financial markets now is similar to what Arrow had observed in the US military during World War II.
It’d be great if the Wall Street forecasts were treated as mere entertainment. But if they aren’t, and investment firms are really using these short-term forecasts to make strategic investing decisions, then the table above is one great example of why no investor should depend on short-term forecasts of the markets.
So now I’m finally circling back to my title for this article and to answer it, I have no idea where the Straits Times Index (SGX: ^STI) would be at year-end 2014. I don’t think anyone has any idea either; you might see one or two people get it right for this year, but then I would highly doubt their ability to continually get it right year-in, year-out.
But even if I can’t know where the index may be in a year or two, there are a few things I know pretty well about investing in an index. (1) Buy it when it’s cheap and it will likely give nice returns over the long-term. (2) Buying an index when it’s cheap gives no protection whatsoever against declining prices over the short-term; what’s cheap can jolly well get cheaper. (3) Buying an index when it’s expensive will likely give you a bad outcome over the long-term. See here for a more detailed description of the three points.
This might naturally lead to the following question: Is the Straits Times Index priced dearly or cheaply now? Just two weeks ago, the Straits Times Index was valued at roughly 13 times earnings and it could “hardly be described as overpriced” back then, as my colleague David Kuo wrote. With the index now at 3,358 points and carrying a trailing Price/Earnings (PE) ratio of 14, it would also be tough to say that it’s anywhere near being overpriced currently.
But that said, it would still be up to the individual’s judgement on how pricey the index is at its current level. After all, the long-term path of the index would also be somewhat tethered to Singapore’s economic well-being (a topic in which individuals may hold very different views) over the next few decades.
In any case, the following table might be a dandy guide for anyone trying to extrapolate the Straits Times Index’s returns over the next 10 years. It shows where the index will be by then given various assumptions about the earnings growth of its 30 constituents and the valuation the market will award the index.
Choose your own adventure from those figures immediately above. Within such a matrix with a huge range of outcomes, you can find “the most honest forecast anyone can give for where stocks will be in 10 years”, according to my colleague Morgan Housel.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.