Tuesday, March 10, 2015

Even a Broken Clock....

Even a broken clock is right twice a day. That would be a better record than that of the “22 chief market strategists” of the largest banks and brokerage houses on Wall Street. In fact, in a recent article entitled How Bad are Wall Street Forecasts? Really Bad, Morgan Housel reports that a blind brainless idiot who predicts the market will go up 9% every year will have a better track record than the smartest men on Wall Street backed by skilled analysts, quality research, super computers, and PhD economists.

Every January these men make a prediction as to where the market will stand at the end of December. The article reports that the strategists were off by an average of 14.7 percentage points per year. The blind brainless idiot was off by an average of 14.1 percentage points per year. Both results are so bad that they are completely useless.

So why do these men make their annual predictions? Why do we listen to them?

We assume that we can profit from the efforts of some team of omniscient experts. Somebody must be able to predict the combined results of every financial transaction, natural disaster, and all the political upheavals that might have an effect on the Dow Jones Industrial Average. Right?


First of all, you are assuming that the men making these predictions are telling the truth. When dealing with investment advisors that is a dangerous assumption. These firms are buying, holding, and selling securities for their own purposes. They have been known to recommend that their clients buy shares in a company that they are dumping like barrels of toxic waste. Likewise, they may be buying exactly what they are telling their clients to sell.

There is another reason they may be lying, fear of a self fulfilling prophecy. While men who are selling their own books or investment newsletter routinely predict the end of the world while offering their secret advice on how to survive the apocalypse, I have never heard the chief market strategist of a large reputable firm prophesize the end of the world. If he did such a foolish thing, all of his investors would cash out their chips leaving his firm without a reason for its continued existence.

Investment is a discipline but it isn’t a science. There is no unifying theory that explains every natural event that might affect the market, let alone the reactions of 7 billion irrational humans to these unforeseen events or events of their own creation like major scientific breakthroughs or world wars.

Even making probabilistic statements about the future is dangerous. During the collapse of 2008 the major investment houses learned the limitations of statistics. Their experts were predicting what actually happened as “a thousand year event.” In retrospect this claim seems truly preposterous. Anything that remotely resembles a modern market has only existed for a few hundred years, yet you are predicting a thousand year event on maybe two hundred years worth of applicable data? Good luck.

There is another problem with probability. Even if you know that a particular outcome is truly a once in a thousand year event, you can’t tell me in advance in what year that event will occur. When we lived in Maryland, we experienced two thirty year floods in one year. Improbable? Yes, but it happened.

Nobody can predict the future with accuracy. Not even you. A little humility and a lot of diversification are good for any investor.

Now please, “Let’s be careful out there.”

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