This article has been reviewed according to Science X's editorial process and policies. Editors have highlighted the following attributes while ensuring the content's credibility: When the U.S. Federal Reserve announces a change in its interest rate, consumers expect shifts in borrowing costs elsewhere and potential price adjustments for things like housing and some consumer goods.
New research, however, shows that stock market analysts generally give a collective "meh" around the time of Fed meetings when it comes to forecasting how much stocks will trade for in the future, called a price target. Despite dozens of Fed meetings between 2000 and 2020 where interest rates were either raised or lowered, researchers at the University of Toronto's Rotman School of Management found that price targets among analysts working at investment houses and brokerages were only adjusted for 18.5% of companies in the two weeks before and after Fed meetings. As a result, those targets—which investors use when deciding to buy or sell stocks—lose accuracy after a Fed meeting, either overpredicting future stock prices when rates rise or underpredicting them when rates drop.
In practice, stock prices on average fall in response to interest rate hikes and rise when rates relax. Comparing actual stock prices to what was forecast, the researchers found that prediction inaccuracy increased by about 13% when the Fed hiked rates and by more than 16% when rates dropped. The study appears in the Journal of Banking & Finance.
That analysts are making such mistakes is "not surprising," said lead author Junhao Liu, a senior accounting lecturer, which is equivalent to an assistant professor, at the University of Melbourne who conducted the research while completing his Ph.D. in the Rotman School's accounting doctoral program. "Analysts always make mistakes, whether intentional or unintentional." The driver of this particular error, show Liu and his co-researchers, is a failure to adjust the discount rate analysts use as part of their forecasting. Expressed as a percentage, the discount rate accounts for things like risk, interest rates and the cost of tying up money over the longer term and translates a stock's future value into today's money.
Not surprisingly, forecast inaccuracy was heightened for companies with high exposure to interest rates, such as financial and highly leveraged companies. It was less pronounced for investment houses with macroeconomists on staff who presumably could provide more precise guidance on potential impacts of interest rate changes. Even having highly rated crackerjack analysts did not help after a Fed rate increase, which happened 29 times during the studied period.
Those hot performers did, however, show less inaccuracy around rate decreases, which happened 28 times. The findings highlight "potential limitations in how some of the most important capital market intermediaries interpret and act upon fundamental macroeconomic information," said Ole-Kristian Hope, who is the Deloitte Professor of Accounting at the Rotman School and supervised Liu's research. The study was also co-authored by Rotman accounting Ph.D. graduate Mingyue Zhang, now an assistant professor in financial reporting at the University of Waterloo.
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