"We have two classes of forecasters: Those who don't know – and those who don't know they don't know."
– John Kenneth Galbraith
Almost exactly 30 years ago, the Dow Jones Industrial Average (DJIA) broke the 2,000 level for the first time. For context, it had taken the index 77 years to break 1,000, which it did at the end of 1972, and then more than 14 more years to first get to the 2,000 level in January 1987. Compare that with the move from 19,000 to just a few points shy of 20,000 in November 2016 which took less than 16 trading days.
Now the math majors among you will be quick and correct to point out that going from 1,000 to 2,000 requires a 100% increase in value and going from 19,000 to 20,000 requires just a 5.25% increase and that is entirely accurate. However, it is not the comparative math behind these moves that causes me to bring them up, rather the reaction to them at the time.
In early 1987, at the dizzy heights of Dow 2k, many said the rise was unsustainable, that a swift return to Dow 1000 was very much on the cards.
Alfred Goldman of A.G. Edwards & Sons in St. Louis predicted "a victory celebration and then a headache". New York money manager Robert Stovall predicted a "groundhog day" effect in which the market would "see its shadow, and promptly duck down again". Mary Farrell of PaineWebber predicted a trading-range for the DJIA for the next few years of 1800 to 2200. By October of that same year, the index had reached 2246.
But then, to the immense relief of these soothsayers, the market crashed over 22% (508 points) in one day on October 19th, 1987, down to 1738 on the DJIA. They, and all the other know-alls who had been biting their tongues from January to October, were suddenly vindicated and their joy and sense of "we told you so" was plain to see.
Although it was more than likely that most of these people had, along with other investors, suffered losses in their investment and retirement accounts as a result of the crash, they reveled in the fact that it now appeared that they were right, albeit many months after their forecasts.
And this is what I am getting at. They were happier "being right" than making money. This twisted human behavioral condition does not just apply to Wall Street managers and financial pundits, it extends to the investing public at large.
The day following the Crash of '87 had to be a record-setting one for the number of people around water coolers (did they have water coolers in 1987?) smugly smiling and saying "I told you so", despite probably being massively poorer than had been 36 hours earlier.
I could roll out plenty of analogies about broken clocks and blind hens pecking corn. And let's also remember that, despite this now infamous crash happening just two and a half months from the end of the year, the DJIA actually ended 1987 up 2.3% for the year!
These "experts" and their followers among the general public who still felt the DJIA had hundreds more points to fall were probably not invested heavily in the market in following years and likely missed the run up to 3754 by the end of 1993, and almost 8,000 by the 10-year anniversary of the crash, well over 4.5x its post-crash 1987 level.
You can see where I am going with this, I'm sure. Who's happier? Person 1, who can claim to be right about predicting an event that cost them a fortune while they also petulantly sit on the sidelines of a rising market (for sometimes many, many years) barking insults at the rest of us who are making money by being invested until their prediction finally comes true, the market corrects and they can smile again (I personally know people who have not invested a penny since completely bailing out in 2008 and are not ashamed of it)?
Or Person 2, who doesn't care to either make or put faith in any forecasts and is therefore not vested in a negative outcome by having boxed themselves in with some public comments and instead makes consistent contributions to investment accounts leading up to, during and after years like 1987, 2001 and 2008?
Person 2 is enormously richer than Person 1. But, hey, Person 1 will eventually get his moment in the sun when he can tell the rest of us how right he was.
Believing predictions allows people to overlook their own ignorance, discount the role of randomness and generally overestimate their own skills. If you think you (or someone else) can predict the future, what you are doing is creating an illusion of control and stability, where often there is none. Order is suddenly created out of chaos, which is very comforting to most people.
From an investment perspective, one of the biggest risks of forecasting is the unfortunate tendency to stay married to one's predictions. Say someone makes or accepts a particular forecast (market up or market down). The market then goes against them. The tendency is not to admit the error, but to double down on the claim.
The fear isn't just that of being seen to be wrong, but looking even more foolish as they change their mind just before their original forecast eventually comes true. It is precisely this fear has caused so many investors to miss big gains or to sell at the lows after a crash.
This is the silly season for market forecasts. You can't move for articles about "The 10 Stocks To Own In 2017", "Bull Market To End in 2017", "Dow 30k in 2017" blah, blah, blah. Disregard them all.
It would just be too easy to pull out these same types of articles from a year ago and look at them now like you might look at a medieval document explaining how the earth is flat and the sun rotates around it.
2016 showed us some startling examples in flashing lights of the futility of forecasting and the uselessness of those who indulge in it. Let's learn the lesson, shall we?
Here is a list of just a few of the people who are always completely unable to accurately forecast markets:
- hedge fund managers
- Wall Street strategists
- bank analysts
- newsletter writers and book authors
- journalists, bloggers and columnists
- any financial advisor and especially stock-pickers
- your dentist
- university finance professors and economists
- your brother-in-law
- the IMF or World Bank or politicians of any kind
- anyone with a Twitter account
- astrologers, psychics and priests
- anyone in the insurance industry
- anyone at the Federal Reserve
- that annoying guy you see on the train most mornings
- anyone on CNBC (including Jim Cramer)
- your accountant
- institutions, mutual funds and pension funds
(list inspired by an article by Josh Brown, "The Reformed Broker")