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Welcome to Silly Season, aka Market Prediction Time

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It’s holiday time, and you’re likely to be celebrating with friends and family, shopping, and thinking gratefully about the year that passed and the year to come.  Very nice! But it’s also time for predictions. For some reason, the changing calendar opens a channel to market observers’ mystical powers, allowing our third eyes to see the future. We make predictions, and investors listen breathlessly. Some of us wind up in the news.

But have you noticed how much financial predictions resemble horoscopes—so broad that they are almost always right, one way or another?

‘The economy will strengthen!’ or ‘Europe will rebound,’ are so vague that it’s hard to be wrong. Eventually these events will come to pass, if only for a few market sessions. And then you can say, “It’s just as [INSERT NAME HERE] predicted!” 

The other interesting thing about these annual predictions: no one ever goes back to judge their success. Let’s assume that a very few predictions come to fruition; would that make investors less likely to focus on them? 

Warren Buffett famously said “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.” 

Yet, predictions make for great marketing. As we all know from the findings of behavioral finance, humans love to create and extrapolate from patterns that may or may not be real. To work as marketing, predictions tend to have four qualities:

1) They have to be very big picture and use broad language that’s hard to evaluate.

2) They are not very actionable. Saying the U.S. economy will rebound—that gives me no information for investing.

3) They should include one number just specific enough to make you credible—and it should not be very different from the status quo. If, for example, you ask 20 experts to predict stock market performance, they tend to be very tightly clustered around, say, 5% to 8% growth for the S&P. What they miss is the really important stuff: the ’08s and ’09s, or the booms. This is when an accurate prediction could make you a fortune or save you from a disastrous loss—but extreme market moves rarely if ever enter the conversation.

4) The risks of being wrong outweigh the rewards of being right. This is why people make wishy-washy predictions. But there’s also a small group of ‘permabears,’ like Peter Schiff, John Mauldin, Marc Faber and many others. Every eight years or so, the market suffers a precipitous decline and they’re proven ‘right.’ They receive accolades as brilliant soothsayers of the market, despite all the years they got it all wrong. 

When a client asks my opinion about a newsletter or blog that predicts something like the price of gold rocketing up to $4,000 an ounce, or a looming stock market crash, I usually respond with a favorite quote from the great investor William Bernstein: “There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor–the investment professional–who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.”

Educated Guesses

Even the most expert investors rely on guesswork, to an extent. Do you want to change your weightings to large caps or small, domestic or foreign? You will make a decision that’s well supported by research and in your clients’ best interests. But at the end of the day, it’s a guess, and you’re as likely to be wrong as right. That was the ‘Aha!’ moment that pulled me away from active investing.

Think about how CNBC puts an ‘octobox’ on the air, and asks eight commentators about an important event. You’ll have successful, intelligent, well-educated people all giving well-supported opinions that vary dramatically. One event, seen through eight lenses.  

During Silly Season, you could make your own octobox, with a row of bullish opinions and a row of bearish opinions. You’ll have a credible, intelligent bull argument on one side and a bearish one on the other. But you’ll still have to figure out who you agree with.

Out of all the noise out there, who has the signal? No one. People may anticipate major market moves—think John Paulson in ’08. But he began predicting it years before it actually happened. And for a long time he appeared to be dead wrong. Will he make another prescient call, and convince us that he knows something we don’t? He hasn’t yet. 

It’s so easy to fall for cognitive biases, even as a professional. You’re more likely to believe the person who got the previous call right. You’re more likely to believe the person who’s an expert. You’re more likely to believe the person who confirms your opinion. 

To tie this all back to the efficient market hypothesis, there are so many brilliant people looking at the economy, the valuations of individual companies, the markets, currencies, hard assets—data is being tossed to such a degree that no one has the inside scoop. What you get is diverse interpretations of the data. You could look at the data through one lens and say the economy’s strong and valuations are fine, and the market will grow. But by focusing on different pieces of data or having a slightly different interpretation, you could say that the economy is strong but valuations are historically high, and the market will decline. How do I know who’s right? Only hindsight will tell. 

Go With What You Know

As a long-term investor, I prefer probabilities to predictions. Dimensional Fund Advisors publishes a grid which shows that, going back to 1927, the stock market has been positive 75% of the time. So, historically, three out of four years the market has been positive. If I have a credible reason to think the pattern will break, that’s one thing. But if I don’t, what should I do? Should I take a disciplined, consistent approach to capital? Yes.

When you look at the data, capitalism works. Innovation, new ideas and new value will continue to drive business and the markets. So we want to take advantage of that and invest in the stock markets. Seventy-five percent of the time it seems to work.

Once I decide that, I look at how I want to own innovation and growth. Additional probabilities show that, over time, certain characteristics have offered a positive return premium over time. Value tends to beat growth, and small tends to beat large, so we use those probabilities to structure a portfolio that is likely to work to our clients’ advantage over time.

We never know for sure—there are no guarantees in investing—but we believe that relying on probabilities is a more rigorous and sound approach than relying on predictions and guesswork. Is it the right approach? Time will tell. 

So here’s my advice. Put down the crystal ball and enjoy your family and friends. Relax and clear your head so you can approach the New Year with energy and commitment. That, plus a consistent, disciplined approach to investing, will do more for you than leaning on market predictions, no matter how ‘expert.’