The Futility Of Attempting to Predict The Markets

We live in a world full of predictions.

People are always predicting things like the weather, the outcome of hurricane season, sporting events and, of course, the stock market. The scary part about all these predictions is how often they are wrong -- and how often individuals rely on them. If humans were such great predictors of events, there would be more far more successful investors and wealthy gamblers. As a bonus, no one would ever get caught outside without an umbrella. The future is unknowable for the most part and making guesses is not a productive way to live or manage money.

Even those with the very best data and computing power are usually wrong more than they are right. Consider the amount of brain and computing power that goes into predicting the weather every day -- and how often they are just plain wrong. Some little unexpected wind gust a hundred miles of away and, instead of a nice sunny day, there can be a deluge of rain.

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When applied to markets, predictions become a very dangerous business, indeed. Unfortunately, those prognosticators who get a big prediction right, usually about a crash, quickly become heroes and legendary forecasters. They are also usually never right again over the course of their career. The history of the market is littered with the results of one-and-done forecasters, and the millions of dollars lost on future predictions, based on what amounts to one lucky wild guess.

As Professor Steven Levitt recently pointed out on the Freakonomics website, “most predictions we remember are ones which were fabulously, wildly unexpected and then came true. Now, the person who makes that prediction has a strong incentive to remind everyone that they made that crazy prediction which came true. Of all the people, the economists, who talked about the financial crisis ahead of time, those guys harp on it constantly. 'I was right, I was right, I was right.' But if they're wrong, there's no person on the other side of the transaction who draws any real benefit from embarrassing them by bring up the bad prediction over and over. So there's nobody who has a strong incentive, usually, to go back and say, Here's the list of the 118 predictions that were false.”

The dumbest question in investing is probably, “what is the market is going to do?” It is unknowable, and yet everyone has an opinion and position on the subject. People back their opinion with facts about the economy, corporate activities such as earnings, new whizz bang products and demographic trends. They are well thought-out arguments, and have pretty much a 50-50 probability of being correct. Investments or trades based on predictions must consider the conditions and events, as well as how the folks who make up the markets are going to react to the event. It is impossible.

The sad part is that, as much money and brain hours that go into predicting the market, it is a completely unnecessary activity in achieving success in the stock market. If investors adhere to the principles of deep value investing there is a natural process that forces investment into markets after they have fallen, and puts pressure to exit stocks as they reach elevated levels.

A look at history shows lots of stocks trading below net current asset value in 2002 and 2003, and just a handful in 2006 as the market reached peak levels. As things fell apart in 2009 there were once again plenty of opportunities to buy very cheap stocks.

The decision to be aggressive or cautious was made by reacting to what the market has done, rather than trying to predict the future direction of the stocks. There is very little money ot be made by attempting the impossible and predicting the markets' direction. There is a fortune to be made by reacting to what the market actually does.

When there are lots of cheap stocks, aggressive purchasing is recommended. When there are not, cash levels should be raised, as stock become fully priced and hold more cash.

It is not rocket science. Just common sense.