Monday, December 10, 2012

"Tis The Season To Ignore Market Forecasts

James Mackintosh had a good piece in Saturday's Financial Times discussing the futility of market forecasts.

Titled "Investing Forecasts Miss the Key Element - Luck", Mackintosh notes that year-end forecasts invariably are incorrect, since short term market movements are essentially random.

Fortunately, most forecasts are quickly forgotten, allowing the strategist to retain a shred of credibility.

Here's what Mackintosh wrote:

If you are confused about how to forecast the next year's returns, don't worry. It is probably not worth the effort anyway.  Over such a short period, chance dominates, as the extreme variations of returns suggests.  Only just over two-thirds of the time was the one-year real return of world shares between minus 12 and plus 23 percent in the past 112 years...Statistically, investors should have little confidence in any base for one-year forecasts.

When I was in business school, I had a professor who said that the movement of the market could be compared to a drunk walking down the street in the general direction of lamp post, hoping to find something to hold onto.  The inebriated fellow would eventually make the post but his path would hardly be a straight line.

The chart above indicates the yearly return of the Dow Jones Industrial Average since the 1920's.  In general, the trend of the market has higher. Still, as you can see, outsized gains or losses during any given year have been more unusual than common. Most years have been in a range, as the following shows:
Histogram showing stock market (Dow) yearly performance
Perhaps the best market forecast was given by J.P. Morgan.  When asked for his market outlook, Morgan is said to have responded:

"It will fluctuate".

And so it will.