A Contrarian Look at 2006

A benefit of this time of year is the abundance of market forecasts for the year ahead.  A contrarian approach is to compile these forecasts to determine the consensus.  If we assume that the forecasts are likely to prove incorrect, (see Bad Forecasts) we can fill in the gaps for a fresh look at what's in store for 2006.

¹

Of course, this approach makes several assumptions such as - the market is 100% unpredictable at a 12-month horizon, and that a survey sample size of 76 economist is sufficient for this type of analysis.  While neither of these is completely true, we'll continue nonetheless.

The mainstream consensus for 2006 is for a year end gain between 2% and 18% with the range 12%-14% being the most popular .  A  smaller bearish contingent sees a year-end finish from -4% to -8%.  There are two outliers at roughly -30% (Barry Ritholtz of The Big Picture)  and +30%.

If we rule out these predictions as unlikely we are left with three scenarios:

Three Scenarios for 2006

Scenario	Return
Strong Bear	< -8%
Mild Bear	-6% to +2%
Strong Bull	+18% +

I think the Strong Bear scenario is unlikely unless the Fed continues to raise rates and significantly inverts the yield curve.  (So far the inversions have been mild and transitory - both magnitude and duration matter).  The Fed says the yield curve doesn't matter, but I believe they will respect the yield curve inversion in their actions.  It wouldn't be the first time they have failed to practice what they preach (see Do as I say, not as I do). 

Based on market valuation and the earnings cycle, I see the strong bull scenario as unlikely as well.  Earnings have been very strong, so a pullback is likely.  For a look at one 2006 earnings outlook see What Will 2006 Earnings Be Like?.

That leaves the Mild Bear as the most likely scenario.

Source:

1.  Anne Tergesen and Bremen Leak.  Fearless Forecasts From The Pros.
Business Week.  December 26, 2005.
http://www.businessweek.com/magazine/content/05_52/b3965408.htm
Data Table: http://www.businessweek.com/magazine/content/05_52/b3965416.htm

2.  Barry Ritholtz.  What Will 2006 Earnings Be Like?.
The Big Picture.  January 15, 2006.
http://bigpicture.typepad.com/comments/2006/01/2006_earnings.html

3. Michael Mandel. Bad Forecasts.
Economics Unbound.  January 3, 2006.
http://www.businessweek.com/the_thread/economicsunbound/archives/2006/01/bad_forecasts.html?campaign_id=search

© 2006 Michael Cale

Comments

[Barry Ritholtz]

Here's a stat for you to consider: During the last secural Bear Market (1966-1982), there were 5 corrections, ranging in strength between 25-45% on the DJIA. Over the course of sixteen years, that averages out to be a major correction every 3.2 years – about every 38 months or so.

The S&P’s last major correction was a 33% drop from 1170 – 780 during March to July 2002. That was 42 months ago – implying that we may be overdue.