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February 06, 2014 at 09:30 AM
Wall Street firms across the board are expecting another year of stock market gains, and California-based quant Ron Surz thinks he knows why:
The cognitive bias known as “anchoring” has set their market expectations around a P/E of 20, and from there they are plugging in their earnings growth expectations to project returns ranging from 13.61% (Weeden & Co.) or 12.26% (JP Morgan) down to .09% (Deutsche Bank) and 2.79% (HSBC).
Of 15 major brokerage firm forecasts, 14 are in positive territory with only Stifel Nicolaus predicting a market decline of 5.32%.
Common to these upbeat forecasts are assumptions that the San Clemente, Calif.-based portfolio manager has reverse-engineered using a matrix developed in the late ’90s by Rob Arnott and Peter Bernstein and published in the Financial Analysts Journal in 2002.
Anyone can use this formula to come up with his own forecast, Surz told ThinkAdvisor in a phone interview, adding that Arnott and Bernstein used it in the late ’90s to accurately predict that the coming decade would be an unpleasant one for stocks.
The formula is quite simple: return is equal to dividend yield plus some estimate of earnings growth times P/E expansion or contraction.
(Bill Gross of PIMCO devoted his February investment outlook released Wednesday to his expectation of P/E contraction, which is why he said that stocks would “lose some luster.”)
The upbeat Wall Street forecasts imply a static P/E of 20, which drove last year’s 30% market rise, along with varying earnings growth assumptions. But Surz, who manages target-date funds for Hand Benefit & Trust of Houston, thinks this is far too optimistic.
