Downturn ahead?

With economic data getting worse and markets looking shaky, the question on everyone’s mind seems to be: our we heading into another economic and market downturn?

Specifically, economic and market data in the U.S. are rolling over, Europe seems to be in full-out recession, and China is growing more slowly with its manufacturing sector even pulling back. This makes everyone wish they knew whether recent trends will continue down, or if a rebound (or central bank support) is on the way.

The reason people care is that it makes a BIG difference on short term returns. If the economy and markets roll over, then you want to be in long bonds, which do great under that scenario. If recent numbers are just a head-fake, and we’re going to see growth resume, you want to own stocks and commodities because they’re dirt cheap assuming growth resumes.

But, the above thinking assumes that it’s possible to know whether the economy and markets will turn down or resume growth. Such an assumption is, however, suspect.

Can experts accurately predict either economic or market downturns? Their track record, contrary to popular belief (and the amount of money you pay for it), is terrible.  

Economists and market strategists, brilliant people who parse economic data on a full-time basis, are dreadful forecasters. As a group, they have never–not once–predicted a recession beforehand. 

Individually, most of them are wrong most of the time. Every once in a while, an economist or market strategist “correctly” predicts a recession or rebound, but no one–and I mean no one–gets it right more than a couple of times. 

Keep in mind that a broken clock is right twice a day–that doesn’t mean it correctly tells time. A market strategist who calls for a downturn all the time will look right one third of the time, and an economist who always calls for growth will be right two thirds of the time. That doesn’t make them accurate forecasters, and that won’t help you get into and out of investments at the right time.

If the experts are consistently wrong, maybe the right place to look is the aggregate opinions of millions of market participants.  Do markets correctly predict market downturns or rebounds?  Not at all.  One famous quote is that “the stock market has predicted 9 of the last 5 recessions.” Translation: markets predict recessions and rebounds much more frequently than they actually occur.  Once again, such guidance does investors more harm than good.

Well, if brilliant experts tracking all the data can’t get it right, and the judgment of crowds can’t do it, what’s to be done?  

First off, accept the premise that, at present, no one has figured out how to consistently time markets over the short term. It’s like forecasting the weather–it’s such a complex and adaptive system that no one knows what’s going to happen ahead of time (even though they can tell you precisely what happened in the past). 

If no one can successfully time the market, then don’t try to do it–don’t try switching in and out of stocks, bond and commodities in a failed attempt to get better returns. Channel Nancy Reagan and just say “no” to market timing.

Instead, do what has worked over the long run: buy cheap and sell dear. Instead of spending gobs of time, effort, and money trying to guess market direction, spend your time trying to figure out which companies to buy and then calculating what price to buy and sell them (relative to underlying fundamentals).

It doesn’t work every time, and it won’t necessarily work over the short term, but it does work over the long term with a high degree of confidence.

Avoid the rat-race of unsuccessfully wondering if a downturn is ahead, and focus instead on underlying value. Your results and your psychological well-being will be better for it.  

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Downturn ahead?

Market strategist = diaper

One of my favorite Wall Street jokes: How is a market strategist like a diaper? They both need frequent changing and for the same reason.

So, why are market strategists full of…um…stuff?  Because timing the market is a waste of time. 

Each year prognosticators try to guess where the stock market will go over the next year, and almost every year they are off by a mile.  This is more likely to be the case in 2011 because almost every market strategist is bullish.  The only thing worth less than a market strategist’s prediction is a group of market strategist’s predictions–especially when they all agree.

Why are market predictions so inaccurate?  Because the things that most impact market returns over a given year are also almost impossible to predict: 

  • Will North Korea lob nukes at South Korea? 
  • Will Israel attack Iran’s nuclear facilities? 
  • Will bond markets abandon Japanese, European and U.S. bonds en masse driving up interest rates? 
  • Will the European Union fall apart? 
  • Will the world economy continue to recover at its current pace? 
  • Will China engineer a smooth or crash landing in an attempt to slow inflation and real estate speculation? 
  • Will U.S. unemployment dive from 10% to 5%?
  • Will drug companies discover a cure for cancer?
  • Will accurate prediction cease being an oxymoron?

None of these thing is strictly predictable, but if any of them occur (except that last), they’d have a huge impact on markets.  You’d have better luck trying to predict earthquakes and hurricanes (things entirely deterministic and yet experts almost never get annual predictions right).

So, why do people crave such predictions?  Because we’d all like a sure thing.  Wouldn’t it be great to have next year’s newspaper and know exactly what stock prices would be a year from now?  We’d all love it, and the entertainment factory that is called news sells tons of advertising each year knowing we’d all love those answers.

But, those answers are worth what we pay for them–nothing. 

Instead of reading the horoscope in hopes that we’ll be lucky today, we should get to the daily grind of making things happen for ourselves. 

That’s what I’m going to do: resist the temptation to read or make predictions, and instead do research on good investments at cheap prices.  There’s a new year’s resolution that works.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Market strategist = diaper