Ignore the Investing Gurus in 2015 — and Every Other Year

Why stock market predictions aren't worth much.

ByABC News
January 16, 2015, 6:23 AM

— -- Every New Year, along with the noisemakers and champagne, self-styled financial gurus make market predictions for the coming 12 months. Armed with the same data that other gurus use in opposing arguments, they come on television as talking heads, post articles online or consume print editorial space to pontificate about what the next year will likely bring investors.

They bring out charts of what's known as the trend line — a graph-plotted line showing the trend of the Dow Jones Industrial Average over a period of years — and they'll base predictions on where the Dow has been relative to this line. Never mind that this depends on how far back they want to start the trend measurement.

These gurus speak in an authoritative tone, as though they were scientists explaining some objective phenomena that they'd discovered after years of laborious research — only no one holds them accountable for their prognostications. By contrast, scientists who are wrong because they jump the gun are shunned by their peers for being imprudent. But financial gurus get away with being wrong most of the time.

There's no way these gurus could ever have a good batting average, because the markets are completely random. There's simply no way to predict market movements 12 or even six months out. Sure, we know many things about the markets now. But that's not what drives significant market movements.

In his classic book, "A Random Walk Down Wall Street," economist Burton Malkiel shows how known information is already priced into investments. At any moment, Malkiel explains, everyone knows what everyone else knows, so the market movements don't turn on this knowledge. Instead, they move on unexpected events, which can't already be priced in. Examples of such events include Russia's invasion of Ukraine, the rise of ISIS and the recent tumble of oil prices. Who predicted these events a year out?

But the gurus aren't completely useless. To the extent that people react to their forecasts and trade accordingly, these predictions can be helpful for savvy yet risk-inclined investors, such as short-sellers, who choose to trade against adherents who react to gurus' advice, assuming enough of them trade heavily enough.

So gurus can have the effect of artificially running prices up or down to the indirect benefit of the few. Regarding the broader market, the artificial nature of this impact means that the accuracy (that is, sustained accuracy) of gurus' predictions decreases as consensus around them increases.

Generally, listening to gurus often leads individuals to take more risk than they should. Many of these people have no problem rattling off predictions because there are no personal consequences for them; they have no financial skin in the game. If you're going to listen to people who make predictions, they should at least be putting their money where their mouths are.

Gurus engage in a foolish exercise (except for the money it brings them). Trying to predict the markets a year out is like trying to get your doctors to predict your health for the coming year. They can't do this because they can't know all the events that might affect your body — what viruses or bacteria might invade, or exactly when certain genetic weakness might catch up with you. Instead, physicians assess the state of your health at the present.

That's all you can do with the markets: Assess the overall status by examining current conditions, noting characteristics that are likely to persist for at least several months while expecting unexpected events. When making your own assessment, keep in mind that almost all long-term stock market returns come from dividends, earnings, earnings growth and valuations — how much you are willing to pay for a dollar's worth of returns in a year.

Also keep in mind that things tend to go back to normal over longer time periods. If a stock is flying high right now, it's more likely to return to its long-term past average than to sustain its high price.

While you want to avoid market timing — darting in and out of the market based on your belief that overall values will be going up or down at any particular time — it's a good idea to keep in mind relevant economic factors that are likely to affect the current market for months to come, although the current economy is one of the most inscrutable in history.

We've been experiencing growth and gradually improving economic conditions since March of 2009. But even this growth is aided significantly by almost every government in the world — including our own — keeping its currency cheap and keeping interest rates artificially low to stimulate growth. The duration of these efforts is unprecedented, and these programs have supported rising equity prices in the United States, muddying the waters concerning what the real values of investments are, or would be without these stimuli.

What will happen when governments unwind these programs? We're in uncharted territory, so there's no way to know. But this is clearly an 800-pound gorilla that you shouldn't be ignoring when evaluating risks.

Even with the stimuli, the U.S. economy is lukewarm compared with the hot stock market. This disconnection indicates that the kind of market growth we've seen in the past year or two may not be sustainable.

Right now, domestic stocks appear to be priced at somewhat above-normal valuations, especially given the slow growth and caution signs in the economy. Most bonds are also expensive, with historically low yields. But emerging markets, European stocks, foreign currencies and most commodities have suffered dismal results. There have been sell-offs in these investments, leaving room for a rebound that would probably mean investors' siphoning money out of stocks, triggering a stock market decline.

There's no telling what 2015 will bring. So it's a good idea to maintain a highly diversified portfolio (owning different kinds of assets), weighted toward inexpensive assets.

Thus prepared for the unexpected, you don't need to expect anything, because your portfolio is girded to absorb negative impacts. That's the prudent course for 2015 — and all years to come.

Any opinions expressed here are those of the columnists and not of ABC News.

Jamie Cornehlsen and Ted Schwartz are advisors with Capstone Investment Financial Group in Colorado Springs, Colo. Cornehlsen is also president of Dunn Warren Investment Advisors in Greenwood Village, Colo. A Certified Financial Planner®, Schwartz advises individuals and endowments. He holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com. Cornehlsen, a Chartered Financial Analyst®, advises business owners and employees on retirement plans. He holds a B.A. from the University of Colorado and an M.B.A. from the William E. Simon School of Business at the University of Rochester. He can be reached at jcornehlsen@capstoneinvest.com.