When it comes to Investing, Predictions are Worthless

Thanksgiving celebrations happened a few weeks ago and thus began the annual holiday season.  And with just a few weeks to go before we put a bow on 2015, some portfolio managers will be scrambling to hopefully take advantage of yet another “Santa Claus” rally…the time of year when stocks seem to consistently rise because, well…Santa is coming, of course.  And by the time the big ball drops in Times Square signaling a new year and a clean slate for money managers, the silly “prediction season” will be in full swing.  Yes, it’s the time of year for meaningless prognostications about what stocks and more are going to do the next year.

For years, I have listened to one market prediction after another.  I used to find it interesting what the “experts” thought.  Now it’s just annoying because they are rarely accurate.  How many market predictions sound something like this:  “U.S. equities should earn a high single digit return this year.” Or maybe something more specific like, “The U.S. stock market will earn 8-10% this year.”  Isn’t this the prediction almost every year?  It’s true that U.S. equities have an annualized return or compound average growth rate of 9.85% since 1928.  But do you know how many years the market ended up between 8 and 10%?  The answer…1, barely!  The S&P was up 9.97% in 1993.  And yet every year investors are given this same tired and misleading expectation.   In fact, it is more likely that the market will gain or lose in excess of 20%, having lost 20% or more six times and earned over 35% a whopping 17 times during the last 89 years.

We, in the wealth management business, get inundated with market data and statistics, market “insight”, financial newsletters and commentary, economic forecasts, and predictions every year on everything.  With the exception of a few outliers, these predictions aren’t bold…in fact they are pretty boring.  They all seem to sound alike.  Which means it probably won’t happen anything like what consensus thinks.  In addition to bad market calls, other poor or ill-timed forecasts can lead to poor asset management.  One call that every expert economist got wrong a few years ago was the date and time in which the US Federal Reserve, the “Fed”, would hike the Federal Reserve rate.  It’s been bantered about, over analyzed and scrutinized, and incorrectly forecasted ever since the Fed embarked on their incredibly ambitious Quantitative Easing program back in 2008.  The Fed, in an effort to avoid a second Great Depression and total financial meltdown across the globe, took extreme and unprecedented measures to save the financial industry from collapse.  Well, for those of us that lived through 2008, the market didn’t collapse.   It just felt like it did.  The S&P lost 37%.  (What were the expert analysts forecasting for 2007?  Do you think anyone on Wall Street got this one right?  It was just going to be another 8-10% year, right? )  Asked back in 2010 when the Fed would begin normalizing rates, not a single analyst or economist predicted it would take this long.  Most were projecting 2011, maybe as late as 2013.  No one thought it would be 4th quarter 2015 and counting.   Not even the Fed.

Of course, these situations are sometimes messy and data dependent which makes managing money very difficult at times.  It most definitely makes forecasting a fool’s errand.  It was certainly rational to think that a recovering economy would have necessitated rate hikes long before now.  And it is certainly reasonable to think that if a market has averaged around 9% for almost 100 years that a predication of 8-10% would be safe.   But markets and economies don’t act rational at times…sometimes for extended periods of time.  Which makes you wonder why smart people consistently make this mistake.

The reason why the timing of rate increases is important is because it will affect many parts of the economy and bond returns.  For example, rising rates will hurt the performance of long-dated bonds, a core holding in most diversified portfolios for retirees.  But had you listened to the experts and sold your long bonds in 2011, you would have missed out on really good returns from a conservative part of your portfolio the last few years.

Markets are unpredictable.  We all know this… which means what should happen doesn’t always happen, or at least not in the time frame one would think.  Proper asset management starts with good risk management.  It’s not speculating on forecasts, which are likely to be wrong.  Such moves can lead to poor asset management and consequently poor performance.  A disciplined approach to managing risk means avoiding big stakes in asset classes, and largely avoiding the predictions.


Next month:  Buy and hold may be dead, but diversification still matters.