About Predictions, Opinions, Outlooks and Forecasts

Count on it!  During the first weeks of a new year, the Investment Tabloids will be filled with predictions, opinions, outlooks and forecasts.  They’re embedded in practically every broadcast on the financial-news channel CNBC. Guests on CNBC are furnished by the investment Industry.  They are knowledgeable, well-spoken, completely rational … and frequently wrong. Every business channel you turn to, and every investment magazine cover will feature gurus making predictions - with great confidence –about what the market is going to do.  Unfortunately, after a while, you begin to realize that the gurus all have a different perspective. Later, it finally dawns on you that they really don’t have a clue. The future direction of the markets is unknowable.

A lot of media content is based on Predictions, Opinions, Outlooks and Forecasts.

Now, let’s look at some of the Predictions made in 2008, during the worst market crash since WWII when investors particularly needed good guidance. Even seemingly objective analysts like Larry Kudlow, (upper right), and the representative from respected British publication Financial Times (lower left), were terribly wrong. And Jim Cramer's exhortation to ‘Buy, Buy, Buy!’ was “wrong, wrong, and wrong.”

Even many CEOs - who should have known more than anyone about the prospects for their own companies - were tragically wrong. One thing the talking heads all had in common was their complete confidence in their predictions and the fact that they were completely wrong.

Business Week magazine's last issue of the year 2007 contained a feature in which leading market forecasters gave their predictions for the coming year--2008 which proved to be the worst one year market decline since World War II.

Their predictions for the S&P 500 for 2008 are indicated above.  Keep in mind, these are not long-range predictions like Nostradamus made.  It’s the last day of 2007.  2008 began the next day! 

Of these 13 well-known and highly-paid forecasters - 11 predicted a positive 2008, and some even a great 2008! Ben Inker predicted a slightly-down 2008, and Bob Arnott offered the most-negative prediction a modest decline of only 8%!

Keep in mind that a 10% pullback is considered normal and to be expected during healthy markets.  The average prediction was for almost a 10% gain. The actual result of the S&P 500 index was a market loss of -38.5%, so they were a bit off-the-mark!

Silly exercises such as this one have become the norm because investors desperately want to know every word uttered by this elite group as if their opinions will somehow help them to know the future direction of the markets.

Not according to this study reported in by the Wall Street Journal in October of 2010.

Professor Phillip Tetlock, of the University of Pennsylvania, studied 20 years of predictions from 284 experts in the fields of politics as well as finance and carefully catalogued the outcomes of a staggering 82,361 predictions.  Professor Tetlock concluded that experts are more often wrong than right … and would have done better flipping a coin!

Tetlock found that the more degrees experts have, the more likely their predictions are to be wrong - and even worse-- to stay wrong - evidently because they think so much of their own opinions, that they refuse to change them, even in the face of facts to the contrary!  

Welcome to Fact-Based Investing

There are 3 major characteristics of Fact-Based Investing

First, and most importantly, there are no predictions.  We are more interested in ‘what is’, and not from ‘what might be.’

Second, Fact-Based Investing accepts no academic theories about market ‘efficiency’ or rationality.  Fact-Based Investing embraces the reality that markets are really inefficient, irrational and unpredictable. Warren Buffet’s mentor; Ben Graham acknowledges this in his book The Intelligent Investor.  In a chapter called “Mr. Market” Graham compares the market to a manic-depressive. Some days Mr. Market is euphoric. Other days, he’s very depressed.  Investors will always overreact to events—whether positive or negative.   

Third, Fact-Based Investing does not require investors to remain fully-invested during prolonged market downturns. When conditions turn factually bearish we expect investors to stampede off the cliffs. We don’t want to be standing in their way.

There are two truths about fact based investing: 

The first of these truths, is that Markets trend.

Trends can occur in any time frame, from intra-day to multi-decade.  The most useful trends for us are those positive Bull Market trends that last from months to years at a time.

And the fact that Markets are irrational and prone to excesses can work to our advantage, because irrationality typically extends these periods of market gains. (This has been referred to as “Irrational Exuberance”). Trends that irrationally extend to the upside can result in Market Bubbles. Trends that irrationally extend to the downside can result in Depressions.

The second truth recognizes the tendency of market performance to persist.

Researchers define this persistence as having ‘momentum.’ The widespread existence of market momentum has been documented over a span of many decades.

In his Second Law of Motion, Sir Isaac Newton said that a body in motion tends to stay in motion.  

Similarly, the stock market can be thought of as a body in motion. Market performance has been shown to be more likely to continue for a lengthy period of time before reversing.  This holds true for both positive and negative performance. 

Here is a 113-year view of the S&P 500 Index.

This chart clearly shows that the market experiences multi-year periods of dramatically-rising prices called ‘Secular’ Bull Markets. These are followed by Secular Bear Markets--multi-year periods of market losses or sideways movement in which the market goes nowhere overall. 

‘Secular’ means “a long period of time. 

In Secular Bull Markets, demand is clearly in control - whereas in Secular Bear Markets, supply and demand fight a see-saw battle, with each gaining the upper-hand for periods of time.

During a Secular Bear Market, it is very difficult for a “buy-and-hold” investor to succeed. But for Fact-Based Investors there can be shorter term (cyclical) opportunities.

About Cyclical Markets
Let's take a close look at the cyclical (short term) opportunities that existed within the  Secular Bear Market which extended from 2000 until 2010. Note that during this time period  the S&P 500 produced no net gains for more than ten years. Nevertheless, there were two distinct downtrends and two distinct uptrends, ranging in duration from one-and-a-half to five years each.

These are called ‘Cyclical’ Bull Markets because they occur within the big Secular Markets. ‘Cyclical’ Bull and Bear Markets regularly occur within Secular Bull Markets and Bear Markets.

Our Fact-Based Investing methodology seeks to identify and capitalize on these Cyclical Bull market trends, to profit from an otherwise-unrewarding Market.

•   Tools to identify secular Bull and Bear trends;
•   Tools to monitor cyclical market momentum.

Our Cyclical Bull-Bear Indicator

Our goal is to be defensive in Cyclical Bear Markets, and to be more aggressively-invested during Cyclical Bull Markets. 

Here is our primary tool for identifying major market trends.

The job of the Bull-Bear Indicator is to determine when a new Cyclical Bull Market or a new Cyclical Bear Market has emerged. This is purely a measurement of ‘what is’, with no predictions or academic theories involved.

Our Cyclical Bull-Bear Indictor is like a barometer.  It uses 90 different market data points to measure market “pressure.”  A high number of positive data points (above 55) are indicative of a strong market.  A move below 45 indicates that a cyclical bear market may be at hand and a reduction in market exposure or an exit from the stock market may be advisable.  

Our Market Momentum Indicator

The Market Momentum Indicator can be likened to a thermostat. When a high number of market sectors are going up, the market momentum is “hot.”

The Market Momentum Indicator is a measure of the expansion and contraction of buying trends in the US stock markets.  Our indicator measures the performance of 36 US stock market sectors.

These 36 sectors cover much (but not all) of the US stock market. The Market Momentum Indicator measures whether buying or selling is the dominant recent activity in each of the 36 sectors.  A “1” is assigned to those sectors experiencing recent net buying, and “0” to those sectors experiencing recent net selling.  Therefore, the total range in which the indicator travels is 0 to 36.

A strong cyclical bull market will take this indicator well above 25 for a prolonged period before a pullback occurs. During a normal market pullback our momentum indicator will often cross the mid-point of 18 and drop down to around 10 for several days before the pullback ends and the bull market resumes.  A prolonged stay below 18 indicates that a cyclical bear market may be at hand and serves along with other proprietary indicators as an early warning system.   

Note:  We use other indicators in addition to those illustrated above to make our tactical market decisions. 

By combining trend and momentum analysis with high-performance portfolio selection, our Fact-Based Investing strategy gives us what we believe to be the best chance of achieving our twin goals:

  To prosper in Bulls, by being in the market and

  To be protected from Bears by being temporarily out of the market or in alternative investment during prolonged market downturns. 

We remain completely open to any eventuality that the market brings. We believe our experienced trend analysis methods coupled with our numerous market indicators will help us to successfully navigate the changing market environments.  

This great lyric, from a song by Don McLean called “You Can’t Blame the Train,” applies to investing just as much as it does to life.

Keep your losses small…it really is the most important rule of investing.

The Law of Exponential Loss

Market pull-backs of 5 to 10% occur frequently. Investors have to accept this. Sometimes, however, conditions arise that lead to prolonged market downtrends—bear markets.  How you handle those years will greatly determine the success or failure of your investment strategy.  Most people are not aware that two of the most important laws of ancient physics can be applied to investments. Newton determined that a body in motion tends to stay in motion.  So too with investments. Galileo found that as a ball traveled down a steep incline, it moved faster—in other words, it gained momentum as it fell. Galileo mathematically plotted this progressing speed on a parabolic curve.

Market losses also accelerate as they decline. A 10% loss can be recovered with a gain of 11%.  Even a 20% loss can be recovered with a gain of just 25%.  Here the math begins to work against you. Before you know it, you’re sitting on a 50% loss and hardly realizing that your investment has to go up 100% to get back where you started!   

“If you aren't prepared to lose tremendous amounts of value, you shouldn't be in stocks."—Business Insider 3.24.2014

The quote above is typical of the advice found in the financial press. Why should we need to be prepared to lose a tremendous amount of value in our portfolio? Why not apply some basic risk management methods such as reducing market exposure? After all, is this not one of the most basic tenants of investing: "buy low/sell high?" 

 Being “all in” the stock market during a prolonged market downturn is just a poor strategy unless you are prepared to disregard the importance of the law of exponential loss and the subsequent capital destruction that can result. The table below shows the damage done to an investor's portfolio during a stock market downturn and the subsequent return required to get "back to even."

Source:  5 Myths of Investing by Lance Roberts Street Talk Newsletter May 2014.  

From the peak in October of 2007 to the end of the downturn in March of 2009 the S&P 500 lost over 50% of its value. This required a 100% gain to recover the loss. This is why the time required in "getting back to even" can be so destructive to capital accumulation efforts.  Clearly, avoiding some of the effects of prolonged market drawdowns is key to long-term investment success.

The above commentary contains opinions and analysis that are provided by the author or licensed for our use for informational purposes only and should not be used as the primary basis for an investment decision.

All P/E references are to the Shiller P/E values, sometimes called PE10 or CAPE, which are calculated so as to remove shorter-term fluctuations; see robertshiller.com for details.

Technology, research, charts and commentary are licensed from the W.E. Sherman Company for unrestricted use in our publications.  This work draws on research by Robert Shiller, Edward Easterling and others.  Portions of the content are often written or modified by Peoples Wealth Management for our clients.   

No strategy can guarantee a profit.  All investment strategies involve risk, including the risk of principal loss.  Thre is no guarantee that our investment objectives can be accomplished.

This commentary is designed to enhance our lines of communication and to provide you with timely, interesting, and thought-provoking information. You are invited and encouraged to respond with any questions or concerns you may have about your investments or just to keep us informed if your goals and objectives change.