Current market conditions provide the perfect environment for the “prediction charade.”
Here’s how it works: We all know the stock market moves in cycles. It has been on an extended bull run. At some point, there will be a correction. Every day, self-appointed financial gurus set forth their views as to why the market is about to crash. They may be right or wrong. It doesn’t matter to them. They know that if they make the prediction often enough, it increases the likelihood they will be right. If that occurs, they earn bragging rights to proclaim they “called the crash of 20____.” They hope to become the new financial seer and that investors will flock to their funds in the mistaken belief they have a window to the future. Here are a few recent examples, among many.
On August 9, Jones Trading Chief Market Strategist Mike O'Rourke opined on CNBC that the S&P 500 index will drop to “1,500 or below.” O’Rourke’s crystal ball is not cloudy. He predicts this sharp decline will occur in the next “six to 12 months.”
Marc Faber agrees. According to ETF Daily News, Faber “made the crash call ahead of the 2008 crash, and predicted the market turn-around in 2009 to the exact day on which it happened.” Wow. Faber must clearly have the ability to peer into the future.
Bad news for investors. Faber, the author of the “Gloom Boom & Doom Report,” sees the market closing lower by the end of the year, “maybe 20%, maybe more.”
Both O’Rourke and Faber appear to be supremely confident of their predictions. That could be a problem. According to the book "Expert Political Judgment" by Philip Tetlock, those with high levels of confidence in their predictions are wrong more often than less-confident forecasters. Tetlock also found that once the media bestowed the mantle of fame on a forecaster, that person then made worse predictions than their less-famous colleagues.
Forecasting interest rates is all the rage now. Most people believe interest rates have nowhere to go but up. Should you act on that belief? A 1987 study by Michael T. Belongia, a senior economist with the Federal Reserve Bank of St. Louis, found that interest-rate forecasts “are unlikely to provide accurate insights about the future.”
According to another study in 1995, an analysis was performed on 28 consensus interest-rate predictions by “experts” that were published in The Wall Street Journal commencing in 1982. The “experts” were wrong almost 75 percent of the time.
Finally, if forecasters could predict anything accurately, you would think it would have been the great recession of 2007-2009. Here’s the sobering conclusion of a study by Herman O. Stekler and Raj M. Talwar of the Department of Economics at George Washington University: “The downturn was not predicted in advance; the consensus did not recognize a recession until Lehman collapsed; and the magnitude of the decline was underestimated. Given the severity of this recession, one can ask why the performance was not better."
The next time you are tempted to rely on forecasts of experts in making investment decisions, remember these words attributed to Prakash Loungani of the International Monetary Fund: “The record of failure to predict recessions is virtually unblemished.”
Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.