The public is sucker for stock market forecasts and predictions.
Without the public's propensity to value stock market forecasts and predictions, Wall Street fatcats would not be so fat. They get fat based on people buying and selling. So the more stock market forecasts and predictions they can get into the press, magazines, on TV, published on the web and into your head, the more money they earn. And you're the chump.
This works for Wall Street because you are an emotional pansy. (I am sorry-I have to call you names to get your attention on this critical issue).
You hear that everyone else is making money so you buy. You hear stories about billionaires selling so you sell. You react immaturely even when your logical side looks at a rich guy like Warren Buffet and observes that he buys and holds. But you're unable to do the same.
The bottom line: you cannot control your emotions and they will always win. However, I don't want you to feel bad about that as you have the company of 7 billion people.
Your only exit from the emotional roller coaster of market forecasts is a strategy or rule in which you have unalterable belief.
The reason you cannot buy and hold is because that rule has failed you too often. You have bought, held, and lost. Therefore, you do not believe that buy and hold works. So your emotions tell you that you must be able to get in and get out of the market at the right time. And for that, you need stock market forecasts and predictions.
Accuracy of Stock Market Forecasts
Unfortunately, those forecasts have no value.
You may know about the monkey test of stock selection.
Princeton University professor Burton Malkiel claimed in his bestselling book, A Random Walk Down Wall Street, that “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.”
“Malkiel was wrong,” stated Rob Arnott, CEO of Research Affiliates, while speaking at the IMN Global Indexing and ETFs conference earlier this month. “The monkeys have done a much better job than both the experts and the stock market.”
Prove it to yourself. Watch CNBC for three days solid. Write down every forecast or prediction. Three months later, check the accuracy of those forecasts. You will find that about 50% are accurate and 50% inaccurate, the same as a coin flip.
And as stated previously, the forecasters may have a personal agenda for their forecast--to get you to buy and sell. Or maybe, given the 50% chance they will be right, maybe you will contact them to manage your portfolio.
If you accept my assertion about the inaccuracy of those expert stock market forecasts, then you need another talisman. Consider a monkey (just kidding). Given that you cannot do the smart thing, buy and hold, let me provide the best rule I have encountered to know when to get out of the market.
The Talisman to Forecasting the Market
This rule has been highly accurate during the last 25 years but it has a cost. You need to lose a little to avoid losing a lot. There is no indicator that tells you to get out at the very top. This indicator tells you to get out when the market has turned sour and is about to turn a LOT more sour.
The rule says to get out of the market when the S&P 500 has a monthly close below below it's 12 month price channel. Here's a picture (click to enlarge).
The chart shows the monthly activity for the S&P 500. The top of each vertical bar is the close for the highest day of the month and the bottom is the closing daily low. The red line above shows the highest monthly close during the last 12 months and the bottom red line shows the lowest monthly close during the last 12 months.
The rule says to sell when the current month ends with a close below the lower red line. That has occurred only twice on this chart since 1992. (I will address when to get back into the market in another post).
Notice that before this rule tells you to get out, you will lose some money. But you avoid the bulk of the downturn.
The beauty of this rule is that if you have faith in it (i.e. turn your emotions over to the rule), then you sleep well at night. No more emotional roller coaster. No more attention or care of the latest talking head's prediction on CNBC. The stock market forecasts and predictions just become noise.
This rule has saved me a lot of money. So many times I have been convinced that the market was about to tank. But the rule did not agree and the rule was correct.
My Opinions vs Rules-Based Investing
Even now, I see nothing but HUGE (or as The Donald says, YUGE) warning signs - everything from the
- debasement of currencies around the globe
- imploding economies (China, Russia, Venezuela, Brazil)
- commodity deflation
- negative interest rates
- unthinkable and unsustainable levels of debt (by the Japanese government and Chinese companies)
- a declining standard of living in the US
- Shall I go on?
- What about the ease with which a foreign government can hack into the New York Stock Exchange or the Federal Reserve and cripple our economy?
- And do you think it's that hard for an ISIS devotee to walk into a nuclear power plant and expose the radioactive fuel to our air and water?
- And how hard would it be for ten ISIS followers to each walk into a different large mall on the same day and blow up themselves?
You see the problems with allowing my thoughts, opinions and worries to seep into my investment decisions. I have learned that my observations, perceptions and calculations have no value for stock market forecasts.
I have learned that my opinions have no value, period. Even the people at Starbucks agree. At Starbucks, $2.40 and my opinion gets me a grande coffee (the coffee is actually just a medium size but the price is grande).
I like to think of myself as an enlightened individual realizing that my opinion (or any opinion) has no value. Those people who lack similar enlightenment actually believe they are right.
"Once in a while you encounter members of the human species with so much intellectual superiority that they can change their minds effortlessly." The Black Swan, Nissim Taleb
I passed the CPA exam at age 19 and graduated with my MBA at age 24. I am clean-shaven and even sound smart when I speak. If I appear on CNBC, you will think my opinion has value. You may have missed it - I had an interview with Ali Velshi on the CNBC predecessor, CNNfn, and you had your chance to value my worthless opinion.
This is my advice (better than an opinion). Please adopt a simple rule (or at most 3 rules) for your investing and find a way to put them above your emotions. You will need to elevate the rule(s) to a belief. Now, even the agnostics can get religion.
Your article is very well written. I like to know more about what is new and i think that we must always learn from each other. Keep it up.