Personal finance: New year forecasts can seriously damage your wealth
THE JONATHAN DAVIS COLUMN
Saturday 03 January 1998
As it happens, a new book which reinforces my prejudices in a telling way has just appeared. It provides a timely reminder of why forecasts of where the markets are heading are at best idle amusements - and at worst downright injurious to your health.
The Fortune Sellers, by William Sherden (published by John Wiley), is not just a book about forecasting the stock market - it looks at the dismal track record of economic forecasts, population projections and so on as well - but it is about as effective a demolition job on the value of market pundits as you could hope to find. He does a brilliant job at debunking the track record of many of the best-known names in the business, including the American market strategist Elaine Gazarelli, who has built a successful career out of being the woman who foretold the market crash of 1987.
(Alas, according to Mr Shelden's evidence, she foretold a number of other market corrections which failed to happen, and her own stock market fund under performed the market when she tried to put her market timing model into practice).
I liked this quote from John Bogle, the founder of the Vanguard fund management firm, on the folly of attempting to make money from timing the market: "In the 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently.
"Indeed, my impression is that trying to do market timing is likely not only not to add value to your investment programme, but to be counterproductive."
A survey of 108 newsletters which claimed to be able to predict the future course of the market found in 1994 that only one had been able to beat the market in the previous five years. The number of mutual funds, meanwhile, which managed to beat the market averages over one, two, three, four and five years was almost exactly what you would have expected if the results had been entirely random.
For those who like corroboration nearer home, there is always the annual forecasting exercise carried out by the Financial Times. Each Christmas it asks a panel of six market experts to try to predict where the main markets and economic indicators will be 12 months later. This year was a particularly salutary indication of how hazardous such an exercise can be.
With isolated exceptions, the six pundits - all highly respected figures in the City - did not even get the direction of the three main markets (New York, London and Tokyo) right, let alone the scale of the move.
With minor exceptions, they expected the London market to stand still or fall (it rose by 22 per cent); Wall Street to fall as well (it rose by a further 19 per cent); and for Japan to recover (instead it fell by 23 per cent).
With one exception in each case, they all expected emerging markets to rise (when, of course, they fell sharply), for the gold price to rise (it fell from $370 an ounce to $293 an ounce) and for the oil price to stay above $20 a barrel (it fell 29 per cent to $17 a barrel).
The experts did, however, have some modest success in forecasting what would happened to inflation, interest rates and the exchange rate (which are related in various ways, and in the end did not move very much at all).
What most studies of forecasting show, interestingly, is that the best track record in short-term predictions is achieved by simply assuming that next year's performance is the same as the previous year's. This so called "naive forecast" is the long-run winner over time for a whole range of different variables, including the performance of the economy.
In the case of stock markets, it may be reasonable to adjust this by assuming that they will continue to grow year-on-year at their long-run rate of growth, which is 67 per cent in, real terms - while recognising that in the longer run, periods of outperformance must be followed by periods of underperformance.
The good news is that for most ordinary investors, the folly of the forecasts is not something that they need to spend too much time worrying about. They are far better advised to spend their time making sensible long-term investment decisions and looking for pockets of value where they can find them.
If you want general exposure to the higher long-run returns the stock market has to offer, then an index fund or a monthly savings scheme with one of the general diversified investment trusts (currently selling at a 15 per cent discount to asset value and a better bargain than an equivalent unit trust) is the obvious place to start.
For those who want higher risks and returns, then trying to pick the right stock or growth fund is the obvious way to go. For those who have a genuinely long-term view of investment, and a higher tolerance for risk, then the current financial crisis in the Far East has undoubtedly made some of the emerging markets look more - rather than less - attractive as an option.
You can, for example, buy Templeton Emerging Markets Investment Trust, a well-diversified fund following a well-established investment philosophy, at a significant discount for the first time in a long time and buy into a number of Asian markets which have fallen by 50 per cent to 80 per cent from their highs.
Those look like good value opportunities for the long term to me, just as gilts looked good value to me when I started writing about their merits two years ago. How good an investment anything will look in precisely a year's time is another matter.
I have my guesses about where the markets will be in 12 months' time, but the mass of scientific evidence has convinced me that they are hunches, rather than opinions of enduring value.
The good news is that of all the skills required to be a successful investor, the ability to know where the stock market indices are going to be a year from now is not one of them. The best new year tip I can offer this year is, therefore, to suggest you quietly put all those forecasts in the wastepaper basket and get on with more fruitful and profitable research.
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