"Newbies"

Humor

Themes & Topics

Glossary

Lecture Notes

Trivia & Factoids

Two Analysts’ Forecasts Diverge by 2,000 Points!

News

Two respected Wall Street analysts have each predicted a 1,000 point move in the Dow Jones Industrial Average (DJIA) over the next 18 months. However, the predictions were in opposite directions. (WSJ, July 31, 1996)

Analysis

I would like to use this news to: (a) highlight the differences in their reasoning; and (b) give you my view as to which one is less likely.

Who Are These Guys?

Byrong Wien, let’s call him Mr. Doom, is Morgan Stanley’s market strategist who has predicted a 1,000 point decline this year. The Journal describes him as "known for flashes of insight and for his annual list of events that most people think are extremely unlikely but that he thinks have at least a 50% chance of happening. Over the years, many of those developments have, in fact, happened, such as Republican victories in 1994 and a big gain in International Business Machines stock the same year."

On the other side of the seesaw is Edward Kerschner, Mr. Boom, Paine Webber's market strategist who has just advised his firm's clients that the DJIA will rise about 1,000 points in the next 18 months. "Mr. Kerschner, who uses a quantitative approach to analyzing the market, has a strong track record. In The Wall Street Journal's quarterly study of asset allocation -- the art of dividing a portfolio between stocks, bonds, cash and other investments -- he led a field of major brokerage-house strategists in 1987, 1990 and 1993. He won points with investors by turning strongly negative on stocks before the 1987 stock crash," points out the Journal. (See also "Bloopers & Blunders" section)

What Is Driving This Divergence In Forecasts?

What is interesting is they have not arrived at these extreme forecasts due to different investment approaches or philosophies. Rather, their interest rates forecasts are at odds. Can you infer what is driving the difference?

If you said inflation, you were right. Mr. Boom must expect interest rates to be coming down. He has predicted that the yield on long-term bonds to go down to 5% by the end of 2001 from its current level of about 7%.

On the other hand, Mr. Doom believes that "the economy will be stronger than most people expect." As we saw in last week’s edition, a strong economy could flair inflation, which in turn will prompt the Federal Reserve to increase interest rates as a measure to fight inflation.

Which Scenario Is More Likely?

As I noted earlier, I am going to argue that the arguments for Doom are not very credible.

A good starting point is some recent inflation figures. On August 1st, the Commerce Department reported that inflation rose at just a 2.1% annual rate, down from 2.3% in the first quarter. Moreover, as I noted last week, the unemployment rate edged up to 5.4% in July from 5.3% in June, another sign that the economy's rapid growth may be slowing. As a result, the yield on long-term bonds has been decreasing.

To support his argument, Mr. Doom also used data on the slowing flow of money into stock mutual funds. However, the latest figures show a reversal. Stock mutual funds took in more than $5 billion in the week ending Wednesday August 7th, the biggest weekly flow in two months, according to AMG Data Services, a tracker of mutual fund cash flows.