New Year, New Market Predictions?

One of the consequences of reading up on personal finance and investing is that people are always looking for your opinion or a tip. This has been especially true for me around the holidays and the recent holiday season was no exception. “I heard on the news that the market is overvalued. Do you think it is?” is a fairly typical question.

I always try to exercise some humility and my response to this sort of question is always something along the lines of “I don’t know.” Perhaps I’m just being brutally honest. I then usually explain that I have a long-term strategy. What happens next week, next month, or next year doesn’t really concern me. Based on the looks I get back I’ve come to find that this isn’t the answer most people are looking for. My feeling is that the people asking this question aren’t just looking to make small talk, they’re looking for some insight as to whether they should buy or sell.

The onslaught of market pundits on television, magazines, papers and the internet have tricked us into thinking that short-term predictions are the way to win when investing in the stock market. That you need to know where the market is going to be a good investor. I generally feel that making these short-term forecasts and acting on them is downright foolish, and I’m not alone in thinking this way. The internet provides us with a valuable tool to help us examine the accuracy of financial forecasts. Wealth manager Barry Ritholtz provided an example in his Bloomberg column last year

Consider David Tice, who this past August warned of a 60 percent market crash. That might be scary, if you were unaware of the fact he made the same forecast in both 2010 and 2012. The first call had something to do with book value (“Federated’s David Tice Sees ‘Huge’ Potential For Decline”). The second was that “Gold Will Surge To $2,500 And The S&P 500 Will Plunge To 1,000.” Meanwhile, gold has fallen by a third and the S&P500 has rallied to all-time highs. Perhaps this helps to explain why Tice’s Prudent Bear fund has trailed the S&P 500 by a huge margin. [1]

Ritholtz continues

As I first wrote a decade ago, to forecast is folly. Today, we have Google Search to help us prove it. Pundits may forget, but not the Internet. [1]

Along those lines Michael Johnston of Fund Reference did an exhaustive online investigation of several top name financial pundits and their various prognostications. [2] The results as you might guess were not so good.

The failure of our ability to predict movements in the stock market is not just the opinion of a few bloggers on the internet. If you’re really interested in predicting movements in the stock market, or predictions in general, I highly suggest reading The Signal And The Noise by Nate Silver. His book is highly accessible and takes an evidenced based approach to predicting all sorts of outcomes from political races, sports performances, weather, and of course the stock market.

Silver tells the story of Eugene Fama. A Ph.D. student at the University of Chicago who studied the returns of mutual funds between 1950 to 1960. Fama found that funds that had recently performed well in one year were not likely to do well in the proceeding years. Active managers were unable to consistently beat the market

“But it had laid the groundwork for efficient-market hypothesis. The central claim of the theory is that the movement of the stock market is unpredictable to any meaningful extent. Some investors inevitably perform better than others over short periods of time–just as some gamblers inevitably win at roulette on any given evening in Las Vegas. But, Fama claimed, they weren’t able to make good enough predictions to beat the market over the long run.” [3]

What the efficient market hypothesis essentially states is that at any given moment stock prices reflect all available information and news. Since we can’t predict what types of events will occur tomorrow, next week or next year we certainly can’t expect to predict the movement of a market based on those unknown events.

There is of course an easy argument against all of this. One can easily point to individuals like Warren Buffett and Peter Lynch. Individuals that were and have been wildly successful investors over the span of their careers. Let’s remember that these are a few individuals among the tens of millions that are invested in various financial markets. In such cases it becomes difficult to differentiate skill from luck. But let’s say that these individuals truly are skilled. Is it potentially possible to consistently predict market movements? Yes. Is it probable? Most likely not. If it were easy then we would all be great at it, and the benefit of investing–those high returns–would likely go away.

Short-term market predictions have never worked out well in the past, but that doesn’t keep the pundits from trying. So long as somebody is willing to listen they are most likely to keep talking. I’ll be ignoring them.

1. Ritholtz, Barry. My Prediction: Your Forecast Is Wrong. Bloomberg. November 11, 2014.
2. Johnston, Michael. A Visual History of Market Crash Predictions. Fund Reference. July 16, 2015.
3. Silver, Nate. The Signal And The Noise. The Penguin Press. New York, NY. 2012. p. 338.

What I’m Reading
Young Money: Solutions for Millennial Financial Worries (Bloomberg)
Bah humbug to ridiculous year-end financial advice (Barry Ritholtz)
I became a millionaire overnight (Vox)
ETFs: Tax-Efficient, Not Tax-Exempt (Morningstar)
When Willpower Isn’t Enough (Freakonomics)