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Wall Street’s Crystal Ball Needs More Clarity

Economists’ year-end predictions were wide of the mark at midyear. BofA’s was the most accurate of the bunch.

It turns out economists at major Wall Street firms have been too pessimistic about unemployment and the European economy, and inconsistent in their predictions on U.S. growth and interest rates. That conclusion is drawn from analyzing how last December’s year-end forecasts by the economists turned out, at least for the first half of the year. T. Rowe Price was generally the most bearish, while Bank of America Merrill Lynch was the most accurate.

On the other hand, rarely were any of the firms out of the ballpark entirely. Also, the conclusion generally comes halfway through their forecasts. Most of the predictions were meant to be for the full year, not merely the first half, and in some cases, the experts specifically foresaw changes in the latter part of 2012. Still, the halfway point is an appropriate time to take stock.

For this analysis, Institutional Investor looked at the detailed year-end forecasts of BlackRock, ING Investment Management, and MFS Investment Management, in addition to Bank of America and T. Rowe Price.

The easiest call was the fate of the euro: Bank of America, ING, and T. Rowe all flat-out predicted that it would survive, and the victory of the pro-bailout New Democracy Party in the Greek elections on June 17 seems to support this thesis — as of this writing, anyway. (The other two firms didn’t take a stand on the issue.)

At the time they were gazing into their crystal balls, the U.S. unemployment rate had been stuck at 9 percent for months, so it’s no wonder the experts turned out to be unduly bearish. T. Rowe Price didn’t expect any improvement at all, while two different people at ING gave figures of 8 and 8.5 percent. As of May, the actual rate was 8.2 percent.

The firms all foresaw some form of recession in Europe. Although technically the continent avoided that label in the first quarter — chalking up zero percent growth — the prognosticators probably ought to be given credit for getting the basic situation right. T. Rowe was the most pessimistic, predicting negative 2 percent growth for the year. Bank of America hedged, saying there was a 50 percent chance of a mild recession (which it defined as negative 0.6 percent growth) and a 40 percent chance of a bad recession (negative 2.5 percent). The others forecast a mild recession.

Not surprisingly, they were all more hopeful about the stronger U.S. economy. Here their predictions can be more fairly compared, because most of the firms broke down their forecasts by the quarter or half. The actual U.S. growth rate was 2.2 percent for the first quarter, so Bank of America was closest to the mark, predicting roughly 2 percent growth for the first two quarters. Again, T. Rowe Price was too downbeat, foreseeing less than 2 percent growth early in the year with a revival later. Meanwhile, ING went too far in the hopeful direction, predicting growth of more than 2.5 percent in the first quarter

When it came to inflation, the firms again were within a reasonable range of accuracy but arguably too pessimistic. Bank of America predicted 1.8 percent for the year and T. Rowe Price foresaw between 1.5 and 2 percent. For the first quarter specifically, ING said 2 percent. In fact, the figure was 1.7 percent in mid-June.

On the other hand, they may have been too bullish in forecasting a rising stock market. True, as of mid-June, the Standard & Poor’s 500 index — at about 1,340 — was well above its level of about 1,250 last December. That could even make BlackRock a laggard for predicting a 2012 year-end target of merely “1,350-plus.” ING, by contrast, saw the year ending at 1,450 to 1,475. However, the index began sliding in May — then rose in early-to-mid June — so it may be too soon to give out awards in this category.

The widest variation in forecasts showed up in the predictions about potential Federal Reserve moves. Both MFS and BlackRock thought the Fed would stop stimulating and raise interest rates, while T. Rowe Price opted for stimulus and Bank of American didn’t expect much change. In fact, at its mid-June meeting, the Fed chose a slight stimulus, pledging to buy about $267 billion in long-term Treasury securities over the next six months. That is less juice than the first round of ”Operation Twist,” in which it bought $400 million, starting last September. But Fed chairman Ben Bernanke also hinted at further stimulus later this year.

In explaining his missed call, MFS chief investment officer James Swanson said, “The bond markets are in a whole new world of yield suppression.”

In a global economy plagued by uncertainty, that’s a sentiment that could be applied to almost any financial sector.

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