Market Forecasting – Investor Beware
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The way the forecasting game works is that the market guru, seer, pundit or executive continually makes forecasts in an attempt to gain public attention. By sheer luck maybe half of these predictions are proven right-meaning that at least half of them are wrong. On the occasions when the forecast turns out to be correct, the forecaster plays it up. Those many forecasts that don’t pan out (and those many investors who are financially hurt by them) are never spoken of again. In truth, you’re much more likely to get an accurate prediction of the future by listening to the weather forecasters. At least they inflict less damage when they’re wrong.
Ned Davis Research and InvestTech recently collaborated to analyze the forecasts of some of the most highly paid and highly regarded market forecasters in the financial industry. This is a small sampling of the findings:
* Out of the 22 high profile panelists on Louis Rukeyser’s Wall Street program for 2001, none predicted the market to close as low as it did that year.
* Out of the 22 high profile panelists on the same program for 2002, none expected the low close at the end of that year either.
* In 2000, at the prestigious Barron’s Roundtable, one of the
11 Wall Street strategists had a forecast that was close to being accurate.
* At the 2001 Barron’s Roundtable, two of the 12 forecasters were close to the actual market year end close.
* In 2002, two of 11 Barron’s Roundtable participants were close.
* In the 2000 issue of Business Week, 52 of the 55 experts (95%) who forecast the year-end level of the S&P 500 were wrong.
* At the beginning of 2002, Business Week again held their survey of “the smartest players on Wall Street.” The consensus forecast of the 54 participants for the S&P 500 was 1292. The actual close was 32% lower at 880. Not a single esteemed participant came close to the actual close.
These findings may seem shocking to someone encountering them for the first time, but they are far from atypical. This is just a small snapshot of how bad the market forecasting business really is. Yet despite mountains of data that showing how ineffective the celebrity market forecasters are, they continue to make their predictions and many unfortunate people continue to base their financial decisions on shoddy, unproven advice.
Market professionals are not alone in their inability to forecast market behavior. Economists do just as poorly. Every six months the Wall Street Journal prints the results of a survey of leading economists who predict the level and direction of interest rates for the coming six months. 55 high profile economists currently participate in this semiannual forecast. You’d think such prestigious economists in such a high profile newspaper would know what they’re talking about, right? Nope. The record shows that from 1982 through the beginning of 2003 (43 periods), 71% of the time the consensus of economists could not even forecast the direction of rates, either up or down, for six months forward. If they’d just blindly guessed they’d have a 50/50 chance, but their actual educated predictions turn out to be much worse. And these are the best the industry has to offer!
So if forecasts are a waste of time then what does work? After 20 years managing money, I am convinced that investors will only succeed when they are able to remove emotion from the investment process. Gut feelings are not a reliable investment strategy-even the gut feelings of so-called experts.
Oftentimes, successful investing requires you to act in a way that is contrary to what you “feel” is right. For example, several of our models measure the overall optimism or pessimism in the investing public. When optimism is high we know that there’s a lot of risk in the market and it’s likely that the market will decline. Likewise, when optimism is low and most investors think that things are really bad, that is usually a great time to invest. This pattern has repeated itself for years.
We take great care to ensure that all of our investment decisions are based on solid, proven models, not hunches. Our portfolio allocation models tell us how much we should be invested based on measured risk in the market. We run the models daily to determine the most effective percentages of investments and cash holdings.
Once we’re in the market, our portfolio focus models tell us where we should be invested. We constantly track all areas of the equity markets on both a macro scale (small cap, mid cap, large cap, value, growth, international and emerging markets) and a micro scale (individual industries, sectors and countries).
The bottom line for Paragon Wealth Management’s clients is that they can be confident that their portfolio isn’t being managed by some celebrity market fortuneteller. Our quantitative models enable us to impartially measure what is actually happening in the market and how much risk there is at any point in time. We constantly evaluate the models to determine how effectively they are working. In my opinion, this is one of the best ways to invest for long term success.
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