The Wall Street Journal featured a helpful article “Happy New Year…Now What?,” (subscription required) that stated:
Collectively, Wall Street forecasts are similarly inconsistent. Since 2000, the S&P 500 has returned a 4% average annual gain, excluding dividends. By comparison, Wall Street strategists have predicted 10% yearly returns, according to Birinyi. And, on average, the consensus always has predicted annual gains, missing all five down years in that stretch.
So what’s my take? My take is that Wall Street strategist forecasts are essentially useless.
Going into 2015, I wrote that SPX options had a skew to the downside, implying that there was more downside risk. Using a similar process, let’s look at SPX options for 2016.
On Thursday, December 31, 2015, the SPX closed at 2093.94. Looking at the SPX December 2016 Options (those that expire on December 16, 2016) and using thinkorswim’s platform for options, I note the following:
- About an 80 percent probability that SPX closes above 1725;
- About an 80 percent probability that SPX closes below 2275; and thus
- About a 60 percent probability that SPX closes between 1725 and 2275 at expiration.
I arrive at these values by finding the SPX value at expiration where the put delta is roughly -0.2 and the call delta is roughly 0.2. I am using option deltas as a rough proxy for the probabilities.
The lower level is about 82 percent of the current SPX value and higher level is about 108.6 percent. Again, we see a skew to the downside because that implies about an 18 percent downside risk compared to about a nine percent upside risk. There is an approximately equal risk that SPX closes below 1725 as there is that it closes above 2275.
Even if the risks were perfectly balanced, there should be a skew to the downside because of dividends. Dividends make puts more expensive. So let’s adjust the put value to incorporate the dividends. SPY dividends have been about 2.4 percent. 2094 times 2.4 percent yields 50.25. Thus, to arrive at the amount of skew while incorporating dividends, we get a higher level of 84.8 percent (equals (1725 plus 50) divided by 2094). Thus, the downside risk of about 15 percent is nearly twice as great as the upside risk of about nine percent.
When learning of various forecasts, remember to keep an open mind. As the opening quotation shows, Wall Street forecasters are traditionally an optimistic bunch. While option pricing models are certainly not crystal balls, they do provide a quick snapshot as to how market participants view the current market. With the passage of time, of course, that view will change. In short, I am not wildly optimistic in my outlook for 2016.