“Prediction is Very Difficult, Especially of the Future”
The above quote, credited to Nobel-prize-winning physicist Neils Bohr, comes to mind in assessing the current market environment and what it may mean for investors going forward. The truth contained in Bohr’s observation is highlighted every year in the prognostications of market economists – but perhaps no more so than in 2008.
Academic research concludes that economists’ forecasting skill is about as good as guessing. Additionally, no economic forecasters consistently lead the pack in accuracy and increased sophistication of forecasting techniques provides no improvement. As Nassim Nicholas Taleb summed up in his best-selling book, The Black Swan, “I cannot find a single convincing argument that tells me that astrologers won’t do better than economists.”
Since the underlying basis of most stock market forecasts is an economic forecast, the evidence suggests that stock market strategists who predict bull and bear markets will have no greater success than do the economists.
In 2008, Wall Street’s crystal balls performed even worse than in the past. At the end of 2007, New York newspaper Newsday sampled “eight major Wall Street Securities firms” and reported an average price projection for the S&P 500 Index by year-end 2008 of 1,653, representing an increase of over 12 percent on the 2007 close.1 As we are all now painfully aware, the S&P 500 ended 2008 at 903 – a little over 45% below the forecast.
Of course, poor predictions are nothing new in the financial world: At the beginning of 2003, with the S&P 500 down over 43% from its peak, the Iraq war looming, and the SARS virus appearing in Asia, commentators were overwhelmingly downbeat about market prospects. Yet in 2003 risk assets delivered tremendous returns with US equities up over 30% and foreign equities up almost 40%.
Based on substantial empirical data and our own experience, we’ve never believed in the ability to add value using an investment strategy that relies on accurate economic or market forecasts over the short term. The fact is no matter how credentialed or experienced the prognosticator may be, he or she is simply guessing what the future may hold.
Given the uncertainty of our current environment, intelligent-sounding predictions about the economy and the market are plentiful today. And investors are naturally drawn to such forecasts in hopes of making enlightened investment decisions. However, economic and market predictions simply are not accurate enough to serve as a basis for prudent investment decisions. Inevitably someone’s forecast will be right, but this is more attributable to chance than skill – and a long-term investment plan should not be left to short-term chance.
1“2008 Outlook for Investors,” Newsday, Dec 31, 2007.