Since the pandemic, Wall Street strategists have repeatedly underestimated the performance of the US stock market in their annual projections, leading to a mad dash to boost their outlooks in the back end of the year. The flurry of upward revisions can look something like a “short squeeze,” which is a situation where traders are forced to cover bearish bets in quick succession, often reinforcing a security’s upward momentum. In that sense, this year has already seen the biggest short squeeze among strategists in a decade, and seasonal trends suggest it’s poised to continue in coming months.
In general, such price targets have always had a spotty record, but this market has proved particularly difficult for strategists to process. First, the outperformance of large-cap growth companies has broken traditional models meant to translate macroeconomic conditions and interest rates into fair values for the S&P 500 Index. Just five companies — Nvidia Corp., Apple Inc., Microsoft Corp., Alphabet Inc. and Amazon.com Inc. — explain almost half the benchmark’s performance since early 2020, which means that macro models are insufficient if they fail to account for their idiosyncratic stories, including the artificial intelligence theme. Though some stocks have benefitted from rising price-earnings multiples, it’s mostly been the underlying surge in revenues and profits that have powered them higher. At a minimum, every strategist should be having lunch with a Nvidia analyst a few times a quarter.
Second, economists and strategists have consistently misjudged the strength of the economy. At the start of 2023, the median estimate showed economists surveyed by Bloomberg thought the US would barely muddle through the year. Instead, it grew 2.5% and lookspoised to do so again this year. Much of the forecast error was probably an over-reliance on old rules of thumb, including the idea that Federal Reserve interest-rate increases typically lead to economic downturns. That may be true in “normal” economic cycles, but not after a pandemic when employers are hoarding labor, consumers are desperate to get back into restaurants and concerts and the typical homeowner has a 3% mortgage rate and is swimming in home equity. Economists may have also underestimated the macroeconomic impacts of capital expenditures from the AI arms race along with President Joe Biden’s industrial policies.
And yet the average strategist surveyed by Bloomberg still sees the S&P 500, which closed last week at 5,648, falling about 3% to end the year at 5,469 (median: 5,600; range: 4,200-6,000).
