Group Think: What's Ahead For Q4?

There's an art to following the recommendations of Wall Street strategists. Taken individually, the average analyst tends to be pretty sharp. They do their homework. They have well-funded research teams. And it can be worthwhile to hear what they have to say, even if their advice tends to be conventional.

But whatever value there is in listening to an individual strategist, you can get an entirely different layer of insight from seeing what they have to say as a group.

That's not to say you should blindly follow their advice. Indeed, as often as not you can even use them as a contrarian indicator and bet against them.

Failure To React
Like all investors, top strategists can be prone to certain psychological biases. They tend to “anchor and adjust” their existing forecasts, which means they fail to fully react to new information. They fall victim to a “recency bias” in that they tend to place undue importance on recent events while ignoring the long-term historical record. They are prone to “confirmation bias,” meaning they look for data that confirms their current view rather than keeping an open mind and letting the data guide their opinions.

And perhaps most of all, they can be prone to herding behavior. We humans crave the approval of others and often think and act as a group rather than as independent-thinking individuals. It’s during times like these that the smart money doesn’t look all that smart.

The Call
That said, let’s see what the smart money expects for the remainder of 2012. In its September 3 issue, Barron’s interviewed 10 prominent Wall Street strategists to get their predictions on GDP growth, the 10-year Treasury yield and the S&P 500. Barron’s also asked each strategist to give their favorite sectors and the sectors they’d recommend avoiding.

S&P 500 Outlook
The opinions were in a fairly tight band. Seven of 10 analysts were bullish, though their forecasts hardly made them wide-eyed optimists. Year-end estimates for the S&P 500 ranged from 1167 on the low end -- a nearly 20% decline from current levels -- to 1480, which is just a modest 3% above current prices. (The poll was taken before the large run-up of the past few weeks, but the forecasted gains would still seem pretty subdued.)

Yields
Forecasts for the 10-year Treasury yield ranged from 1.5% to 2.4% with an even 2% being the most common answer.

Given that the 10-year yields 1.57% as I write, the strategists would seem to be putting out mixed signals. They see an economy strong enough to send Treasury yields up by nearly a quarter, yet they see only modest stock market gains. It’s hard to see both of these forecast being correct.

Technology
The sector choices tell an interesting story as well. Fully half of the strategists recommended technology, which is high but not out of line for this group, while one recommended avoiding it (the one that recommended avoidance was bearish software, but bullish hardware). Technology has been highly recommended for a couple years now though I don't see that as a sign of rampant herding.

Healthcare and energy were also popular choices, garnering four votes each.

On the bearish side, no one sector was singled out by the group. Materials received the highest number of “nays” at four, but I would hardly consider that a consensus. Bearish sentiment was pretty evenly distributed across sectors.

Muddled And Confused
Overall, there are no obvious conclusions to be gleaned from the smart money this time around. They seem as muddled and confused as the rest of the investing public. If anything, a contrarian might take a look at their lack of strong conviction and see it as a bullish signal to tack on a little risk for the last quarter.

This article first appeared on MarketWatch.