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Portfolio > ETFs > Broad Market

The Perils of Prognostication

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Irving Fisher was a noted 20th century economist. No less an authority than Milton Friedman called him “the greatest economist the United States has ever produced.” However, he made a statement in 1929 that all but destroyed his credibility for good. Three days before the famous Wall Street crash he claimed that “stocks have reached what looks like a permanently high plateau.”


Sadly, mistakes like that have been all too common. Y2K anyone? Or how about the book by James Glassman and Kevin Hassett in 1999 entitled Dow 36,000? That book’s introduction states: “If you are worried about missing the market’s big move upward, you will discover that it is not too late. Stocks are now in the midst of a one-time-only rise to much higher ground—to the neighborhood of 36,000 on the Dow Jones Industrial Average.”

Sadly, it didn’t exactly work out that way and a used paperback copy of the book may now be purchased online for as little as a penny. It isn’t even worth that much except perhaps as a reminder of the perils of forecasting.

More specific market predictions do not generally fare any better. Back in 2000, Fortune magazine picked a group of 10 stocks designed to last the then-forthcoming decade and promoted them as a “buy and forget” portfolio of their best ideas. Unfortunately, anyone who purchased that portfolio would want to forget it.

If one had invested $100 in an equally weighted portfolio of these stocks back then, 10 years later one would have been left with only $30. So much for Fortune’s market-timing and stock picking abilities. 

Of course, there are many similar—even worse—examples. In December of 2005, Fortune (again!) was pitching “10 sturdy stocks” that it claimed were “built to last.” Citigroup at $50 and Washington Mutual at $42 featured prominently. Within two years, both of these stocks were well on their way to zero. That’s actually zero

Now, consider the range of estimates made by the major investment firms for the S&P 500 in 2011; these were, of course, made at the beginning of the year for where the index would end the year. The average, or mean, of the estimates was 1,400.

Strategists from most Wall Street experts predicted 10-12% market growth for 2011 while only two called for minor declines. Ken Fisher of Fisher Investments called for the decade beginning in 2011 to be as good for the markets as the 1990s. Overall, most institutional and individual investors were quite bullish, while advisor confidence was at a four-year high

Most of these experts, who are highly educated, vastly experienced, and examine the vagaries of the markets pretty much all day, every day, will necessarily be wrong and often spectacularly wrong based upon the disparity of the predictions alone. One can look at many other high profile stock pickers and find numerous tales of woe (more here).

Indeed, all available evidence indicates that any attempt to engage in market timing is doomed to failure.  If you think you can predict the future in the markets, think again. Your crystal ball does not work any better than anyone else’s.

This past week’s market machinations pushed the point even further.  

As Barry Ritholtz noted (the chart above came from his excellent blog, The Big Picture), Rule #9, from Bob Farrell’s Market Rules to Remember, states as follows:  “When all the experts and forecasts agree—something else is going to happen.” The S&P 500 closed last week (Aug. 5, 2011) at 1199.38, a drop of more than 10 percent since the end of the Fed’s second easing program (QE2) and substantially below even the lowest year-end prediction listed above. 

As it stands today (remember, however, that a lot can still happen before year-end), none of these experts looks likely to be right or even close.

This is not to say that market performance is entirely random and in no way predicated upon value.  As I wrote in my Investment Outlook 2011 back at the beginning of January (available here):

“Even though the majority of analysts are proclaiming that all is well in the financial markets and that investors should expect outstanding returns in 2011, I am decidedly less sanguine. Serious questions remain about both the existence and depth of the purported economic recovery nationally and globally. I am also concerned about the extent to which the economy and the markets have been propped up via government action, inaction and intervention.

“For a true recovery to take place, we need changed behavior at the governmental level and we can use it at the individual level too. We are not saving enough. We are not planning enough. We are not careful enough. Without serious and significant change, something has got to give. Because I am skeptical that significant change will happen or will happen soon enough, I can’t join the ranks of the bulls.”

As I pointed out then, “[i]t is hard to stand alone. It is dreadful to be wrong alone. But doing what is best for clients requires making some tough calls and some tough choices. The herd says ‘Buy.’ I say, ‘Be careful.’” 

More specifically: “The anticipated clear sailing could indeed come to pass and might even last for a good while—perhaps all year. But such favorable market conditions will only last until, inevitably, they don’t. When it comes, I expect the change to be rapid and the drop deep. Economic and market difficulties create a variety of risks and problems. But they also create tremendous opportunities. I therefore encourage investors to remain skeptical, cautious, defensive and opportunistic. In 2011, investors should look to take advantage of the opportunities that present themselves while carefully managing and mitigating risk.”

In a secular bull market, one’s primary goal should be maximizing returns.  In a secular bear market (like we face now), the key goals are to preserve capital and to mitigate risk.  Doing so is not easy.  Indeed, although my Outlook looks pretty good today, it could all blow up in my face at any time. 

As John Maynard Keynes famously pointed out, “The market can stay irrational longer than you can stay solvent.” So beware of predictions—mine included.  Even so, it still makes tremendous sense to plan and prepare (carefully) so as to find value in a precarious marketplace.


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