Forecasting Consumer Guide — Part II: Level versus Direction
About this time a year there was a CNBC program involving three excellent and savvy market observers. Ron Insana was the host and his guests were Art Hogan and Louis Navellier. They had a general discussion about the market and valuation. The guests agreed that values were attractive given earnings forecasts, the state of the economy, and interest rates. They both seemed to feel that the market was undervalued on these criteria.
But when Ron asked for forecasts, Art Hogan predicted up 8% and Louis Navellier called for up 35% or so, consistent with his assessment of the undervaluation. Insana seemed a bit puzzled by Hogan’s forecast, given his apparent attitude about valuation. He asked "Why 8%" and Hogan answered that he expected earnings growth to be about 8%.
This is typical of the difference in approaches between strategists for a firm and fund managers. The strategists, even if they believe that the current market multiple does not reflect forward earnings and interest rates, do not predict a multiple expansion. They accept the current market verdict on valuation as "given" and look only for factors that can change direction. These pundits speak in terms of "headwinds" or "tailwinds" or other new developments. They are implicitly accepting the Efficient Market Hypothesis, that the underlying valuation verdict will not change. Even if a strategist is a bit more bullish or bearish than his colleagues, there is little reason to take an extreme view. Being a little more bullish is enough to claim a superior record without looking foolish.
It is different for a fund manager like Navellier. He can do his bottoms-up analysis on earnings and expect that eventually multiples and interest rates will revert to their traditional relationship. It does not really matter if the market is only up 10 or 15 percent, since he has his investors properly positioned. Please note that this approach is an honest forecast of where the market should go to achieve the analyst’s fair value target.
A consumer of forecasts should listen carefully to whether the pundit talks about valuation. If there is a discussion of valuation, there are crucial questons: Does the pundit merely talk about average P/E ratios, or is there some acknowledgement of why interest rates are important? Is P/E discussed as reported earnings or operating earnings? Is it a backward-looking "forecast" or does it acknowledge expected or forward earnings?
You can tell a lot from what is left out, not just what is said.