Confessions of an Investment Manager

When I studied Economics and Finance in business school, I learned many useful things about investing, but over time I have discovered that they were not nearly enough.  Here are the exceptions to what I learned in graduate school, as well as some new realizations.  Sometimes, what you think you know is incomplete or just plain wrong.  And sometimes, you learn things you never knew you never knew.

Yes, Virginia, bubbles do exist.  Years ago my professors downplayed the importance of speculative bubbles, but I think the evidence is clear.  In the last 15 years I would argue that we have had (at least) four separate bubbles.  Two of those bubbles have already popped, and of those I am sure there will be no disagreement.  Bubble #1 was technology stocks (remember all of the dot-com companies?) of the 1990s and bubble #2, housing prices, which from 2001 – 2006 went sky high, simply because people fell in love with the sure-fire benefits of owning them. 

Now, I cannot prove it yet, because prices are still high, but I believe we have had a bubble in gold, and to some extent, silver prices.  (I wrote about this last November.)  The phrase “as good as gold” has a long history and a certain charm, but I would not bet my own money, nor my clients’ money for that matter, on whether gold will continue to do so well. 

A Bond Bubble?

I believe that we have also had a bubble in bonds.  Admittedly, bonds have done extremely well in the past, but you don’t win a race by looking backwards.  Are too many people flocking to the supposed “safety” of bonds?  We will see.

Diversification works, but not always.  It is foolish to concentrate your investments in a narrow selection of securities.  Because we cannot predict the future, we diversify.  But in a crisis, when investors are panicking, most assets fall, in lock step.  

There have been some exceptions; we can count on cash to be stable, and money market funds have been a safe, if not very profitable, bet.  U.S. Treasury bonds usually rise when other riskier assets are falling, but even this may change at some point in time.

A fairly quick recovery of the economy usually follows a recession, but not if it is caused by a financial crisis. This is something Carmen Reinhart and Kenneth Rogoff demonstrate in their book: This Time Is Different: Eight Centuries of Financial Folly. We are living through a very slow recovery, which should not surprise us, given the financial crisis that started the Great Recession.

Decisions by the Federal Reserve are very important but not a sure thing and, certainly, not always the right thing.  The Fed can influence interest rates, the economy and people’s expectations.  They can slow the economy down when it is overheated, and they can give it a boost when the economy is not growing, but there are limits to just how much they can accomplish. We will learn more about this in the next few years, as events are still unfolding and history is still being written. And, speaking of history, it has shown us (witness the Great Depression) that the Fed’s decisions are not always the right ones. The hope of course, is that they, and other central banks, have learned from past mistakes.

Those in the know, don’t always know.  Economists are not very good at predicting anything useful: the growth in the economy, interest rates, exchange rates, stock prices.  Top management of a publicly traded stock may be buying their company’s shares like there is no tomorrow, but they can be wrong.  Hedge fund managers who have had spectacular results can make bets that turn out spectacularly wrong.  Investment “experts” are right some of the time, but are wrong frequently.  (See this post.)

Investor behavior is more important than investment returns.  To get the long term returns that stocks have delivered over time, you cannot periodically panic, sell your stock investments, and “go to cash.” If your strategy is to “get back in” at a safer time, you will undoubtedly miss the rebound in stock prices. (If you were out of the stock market in 2003 or 2009, you cannot get those large returns back.)  Just because the media and your friends are telling you how terrible things are, don’t go along with the “end of the world” story.  (See this post.)  If you do panic, you will almost certainly hurt your results. 

Conclusion

I am thankful that I learned Micro Economics, Macro Economics and Monetary Economics from some wonderful professors.  Knowing what incentives drive producers and consumers and how markets work is very helpful. But it is not enough. 

In graduate school, I loved studying Modern Portfolio Theory.  MPT was so new that we read the original groundbreaking work, before it was even in textbooks.  But I am always looking for practical ways to implement it. 

Understanding risk premiums and historical returns of various investments is useful, but it is not sufficient.  Mathematical models are helpful, but they are not foolproof.  To me Portfolio Optimization is a useful framework in theory, but not very practical in application.

We should always remember that people and events are not as predictable as we would like to think.  Economics is a social science not a physical science. Psychology frequently plays an important and changeable role.  We should not forget that our crystal ball is always cloudy.  

 

Admitting Ignorance

“After more than a quarter-century as a professional economist, I have a confession to make: There is a lot I don’t know about the economy.” – N. Gregory Mankiw.

The well-kept secret that the media won’t tell you is that, in spite of the fact that they do it all the time, economists find making predictions fairly tough, and they’re really not very good at them. 

I’ve commented on this before, and past posts are grouped under the Series: The Cloudy Crystal Ball.

If You Have the Answers, Tell Me

In this Sunday’s New York Times column, Harvard professor and economist N. Gregory Mankiw admits with some humility what he doesn’t know.  And he doesn’t know a lot, apparently.  That list includes the very things we care and worry about as consumers, investors, Americans; things such as the future direction of the U.S. economy and unemployment, the future amount and impact of inflation on consumer spending and business investment, and how long the U.S. government will be able to borrow money at such low interest rates.

How refreshing for a professional economist to be humble.

Professor Mankiw’s column is brief and well worth reading.

He concludes with this, “If you find an economist who says he knows the answers, listen carefully, but be skeptical of everything you hear.”

Larry Swedroe has, for many years, expressed similar skepticism about the ability of forecasting to add value.  Mr. Swedroe is director of research for The Buckingham Family of Financial Services, author of several books that I have read with great pleasure, and he is my absolute favorite blogger at Wise Investing.

Never In Doubt, Often Wrong

Here is something he said in 2002.

The track record of economists is dismal (perhaps that is the real reason it is called the dismal science). The track record of market strategists is equally dismal. Despite this, the press and media focus on forecasts (though rarely holding the forecasters accountable, for accountability would end the game) and investors pay great attention to them; allowing the forecasts to influence or even determine their investment strategy.

Buckingham’s Swedroe on Housing, Oil, Investing

In a recent interview aired on Bloomberg TV, which is well worth viewing in my opinion, Swedroe said emphatically, “There are no good forecasters.”

Not merely offering a criticism of forecasters and prognosticators, he also discusses the “right way” to invest.  Specifically, Mr. Swedroe advises controlling risk by widely diversifying, keeping costs down and keeping taxes low.  And, of course, by not buying actively-managed mutual funds. 

Amen.

Freedom from the Press

While freedom of the press is crucial to a well-functioning democracy, reading the financial press may be hazardous to your wealth.

One of the worst things investors can do, right now, is to pull out of the stock market because (they think) “the end of the world is upon us.”  The truth is that many people “throw in the towel” at just the wrong time.  And, certainly, the media, all too frequently, plays into (and plays up) that irrational fear, and usually at just the wrong time.

Several articles, had they been taken seriously, might have scared you right out of the stock market.  If you had followed the very typical story line of “now is a very risky time to be investing in stocks” you might have missed out on the best September since 1939.  In that single month, the Standard & Poor’s 500 Index gained 8.8%!

Here are just a few of the recent articles that could have led you astray.  (And note, please, the usage of the word “flee” in the title of the first two articles; I can’t help but relate the word “flee” to those old Godzilla movies, where everyone is haphazardly running for their lives.)

Small Investors Flee Stocks, Changing Market Dynamics, Wall Street Journal, July 12, 2010

“Many individual investors were tiptoeing back into stocks in the spring. Now, they’re running for cover again.”

“Individual investors were important market pillars in the 1990s, but their flight from stocks is changing the market dynamic.”

The article actually pictured a smiling couple who “sold the last of their stock holdings on May 20, moving the money to bonds, certificates of deposit and bond-like annuities.”  What unfortunate timing!  I’d be curious to see if they’re still smiling.

In Striking Shift, Small Investors Flee Stock Market, New York Times, August 21, 2010

Renewed economic uncertainty is testing Americans’ generation-long love affair with the stock market.

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.

The New York Times and The Wall Street Journal were not alone in trumpeting doom and gloom.  There have been similar articles in USA Today and Fortune.  Even The Atlantic weighed in with a fabulous title: The Great Stock Myth.

For an astute analysis (and a thorough debunking) of the Atlantic’s article, read Larry Swedroe’s August 30^th post, Are Stocks Really Doomed?

Conclusion

What can we learn from reading (and then completely disregarding) such inflammatory articles?  We learn that they are not at all helpful for long-term investing.  Articles of these types almost always appear after periods of low returns and/or increased volatility of stock prices.

What we know is that, yes, stocks are risky.  And, yes, prices fluctuate.  And, (a very emphatic) yes, we are all facing serious economic and political challenges.  And, perhaps some people should have a significant amount of their money invested in fixed income securities. 

But your portfolio should depend on an individual assessment of your goals, your time horizon, and your ability and willingness to accept risk.

Your long-term investment strategy should definitely not depend on – nor should it be influenced by – what you read in the media.

The Stock Market Declined, Now What?

“Don’t let short-run fluctuations, market psychology, false hope, fear, and greed get in the way of good investment judgment.” – John Bogle.

Last week I was contacted by Sarah Morgan, a writer for SmartMoney.com, who had some questions about the recent volatility and decline in the stock market.  Normally, I don’t respond to the press, but her initial question struck me to my core.  Ms. Morgan wanted to know if clients were panicking.  My clients?  Panicking?  She obviously did not know me or my investment philosophy.  My email response to her was this, “I would take it as a tremendous failure of education and preparation if my clients were panicking now.”  

I went on to say that in trying to time the market (which, as I’ve said before, is patently impossible) investors are more likely to hurt themselves by not being invested when the rebound comes.  And, as historical data prove, there is always a rebound, because the long-term trend is up.

I admit that I took pride in being able to tell Ms. Morgan that clients of Key Financial Solutions do not panic.  Rather, they sit and hold tight and ride out the roller coaster.  They’re prepared for short-term fluctuations and declines, simply because they have a long term plan.

Their Investment Policy Statement specifies a well-balanced portfolio that includes a combination of stock mutual funds and bonds (in ratios that we have decided upon, based upon time horizon, risk tolerance, etc.).  So, even a 10% decline in the stock market has little effect on my clients.  And should a market decline be steep enough to affect a portfolio, rebalancing – selling some (appreciated) bonds and buying some (now, underweight) equities – is appropriate to reestablish the portfolio’s target mix.     

That information was enough to spur a half-hour long phone conversation and a follow-up email. 

It was gratifying to read the article, After Market Slide, What’s Your Next Move?, and not just because I was quoted.  No, I was happy to see that Ms. Morgan got it right. She quoted a number of people who said that long-term investing is the key to success.

Having a well thought out Investment Policy Statement is the best chance I know of to stick with a long-term plan.  When markets experience extreme volatility, it sure helps to have a strategy that is based on more than a prediction of what today’s news means to your investment portfolio.

And what are the rewards of long-term investing versus the risk of getting out of the market?  Christopher Davis of Davis Advisors gave a presentation at the NAPFA (National Association of Personal Financial Advisors) National Conference.  Here is what he reported.

Average Annual Returns for 1995 – 2009 for investing in the S&P 500

8.0%		for Staying the Course
3.2%		if you missed the 10 best days
-2.6%		if you missed the 30 best days
-9.2%		if you missed the 60 best days

 

For a fifteen year period, if you missed the 30 best days, you could have managed to lose 2.6% per year, versus earning 8.0% per year.  Thirty days in 15 years!

So let me turn the original question on its head, “Why would anyone risk being out of the stock market?”

Investment Pornography, Part 1

Caught your attention, didn’t I?  Please don’t be offended by the title of this post, and please don’t snigger over it.  This is serious business, after all. Also called “Financial Pornography,” investment pornography consists of (1) alluring magazine cover headlines promising juicy riches, (2) articles featuring exciting ways to capitalize on supposed opportunities and (3) outlandish claims and predictions that may, in fact, be bad for your financial health. Finally, it has no redeeming value whatsoever (except that it is good for a laugh).

When I go to conferences held by Dimensional Fund Advisors, one of the best run and most respected mutual fund companies, the lecture known affectionately as “Investment Pornography” generally gets the most attention and the most nodding heads of recognition. The presentation consists of articles from popular finance magazines followed by a quick analysis of what actually happened. Punchline: They were spectacularly wrong, time and time again.

Future posts will cover articles that are way too optimistic and were written simply to get you riled up enough to buy a magazine, newspaper or investment newsletter. Today’s topic is of the other kind of Investment Pornography, the alarming article that promotes fear. This is the other side of the outlandish approach to getting your attention.

Sympathy and Recognition

I feel sorry for a journalist who covers the stock markets. A writer typically takes the financial news of the day (which is, more often than not, pretty muddled), and tries to make some sense of it by quoting various people who at least sound as though they know what they’re talking about.

The fact is that sometimes stock prices go up and sometimes they go down, and sometimes they don’t do anything. And no one can predict what is going to happen next. That’s why it’s best to be a buy and hold type investor. But, really, who would read that story over and over? Would you?

So although writers try to be accurate, relevant and interesting, they frequently stray into making predictions. In my opinion, trying to predict the future is futile, and can be downright dangerous. Sometimes a writer will positively mislead you and convince you to do something you will regret.

Fear Mongering

A year ago, on March 6, 2009, I took the New York Times to task for fear mongering at (possibly) just the wrong time. By coincidence the stock market hit its actual bottom a year ago on March 9th, the next business day. Read that post for an egregious article that, if followed, would have cost you dearly.

While, in general, I love the New York Times’ reporting, here is a recent example of fear mongering from the January 25th article, Volatility and Politics Spark Fears of Market Correction, by Javier C. Hernandez.

Here are some questionable quotes with my comments:

“Brace yourself for another wild ride on Wall Street.” (Sounds scary, doesn’t it?)

“Worries about the strength of the global recovery and proposals from Washington to clamp down on banks have sent fresh jitters through financial markets, prompting chatter among traders that stocks could be poised for that rare but alarming phenomenon: a correction.” (Rare and alarming? Not really; it happens more often than you’d think.)

“Over three tense days last week, stocks tumbled nearly 5 percent; the Dow posted triple-digit losses on Wednesday, Thursday and Friday, ending the week at its lowest level since November.” (So? Five percent declines are quite common and mean nothing. Three days should definitely not make anyone “tense.”)

“Some analysts believe the downward momentum may continue.” (True, but other analysts don’t.)

“A confluence of all those headwinds creates a perfect storm of uncertainty on a market that had already been a bit vulnerable to a pullback,” said Quincy M. Krosby, a market strategist at Prudential Financial. (“Perfect storm”- nice phrasing; I sure hope that it didn’t convince you to abandon a well-thought out plan, though.)

“A severe decline in the market is far from assured. There are no certainties on Wall Street, and stocks have been known to bounce back after similarly turbulent periods.” (Thank you, thank you, thank you! I couldn’t have said it better myself.)

“In the near term, an unusual degree of uncertainty may bring more losses to the stock market.” (Yes, and then again it may not.)

Fast Forward Five Weeks

By contrast, after the market had gone up, the New York Times had this March 5th article: Markets Find the Upside of the Jobs Report also by Mr. Hernandez.

What a difference five weeks makes! Now, after the stock market has gone back up, we read “better-than-expected snapshot of unemployment in the United States lifted Wall Street on Friday, reinforcing hopes that the job market — and the broader economy — might be gaining strength.”

Here are more quotes with my comments.

“The fact that unemployment is not getting worse is great news for the market.” (First of all, it is possible that statistically the recession has already ended. Second, the unemployment news tells us only what has already happened, not necessarily what the stock market will do.)
…

“In light of that uncertainty, the question for Wall Street is whether the upward push can endure.” (You are free to guess what the stock market will do short-term, but no one knows.)

…

“The major indexes have recovered from their losses in January, and they are in positive territory for the year. Last week brought strong gains, with all three indexes ending the week more than 2 percent higher.” (Good thing we didn’t bail out and sell after reading that January 25th article, hmm?)

Enough

I am not picking on the New York Times. It is a must read for me every day, for its reporting and also for its opinion columnists. In truth, if I had to give up either reading the New York Times or watching TV, it would be a difficult choice.

And the New York Times is certainly not alone in its fear-mongering role; almost without trying, you can easily find dozens of predictive articles in most, if not all, national publications.   Money magazine has had many silly articles that would have cost you big bucks.  SmartMoney is frequently not-so-smart.   Business Week and Forbes should be ashamed. Time magazine is well known for its lurid front covers of Depression-like photos.

My advice is to ignore such articles, because they are in fact “Financial Pornography.” They attempt to, and often succeed in, getting people riled up, by either pandering to fear or greed. More likely than not, they are heavily influenced by what has already happened.

If they correctly predict what the markets subsequently do, it is merely a coincidence, in my opinion. Save your time and your money. Pay no attention to sensational articles with worrying predictions, or ones that identify sure-fire investments for that matter. By the time you read the story, any relevant facts are already reflected in today’s prices. It is too late to consider what you read to be useful, actionable information.

Do not be influenced by short term fluctuations or worrying articles. It is much better to have a plan and to stick with it.

Brawl Street: Jon Stewart vs. Jim Cramer

The Daily Show With Jon Stewart	M – Th 11p / 10c
Jim Cramer Unedited Interview Pt. 1
thedailyshow.com
Daily Show Full Episodes Economic Crisis Political Humor

I’m not a fan of the financial advice dispensed by CNBC’s talking heads. The “advice” is contradictory, often based on someone’s guess, and certainly not geared to your individual situation.

I find Jim Cramer, of Mad Money, particularly difficult to watch, and it’s not just the bombast. I believe that none of his recommendations make any sense. He is telling viewers which stocks will do well and which will do poorly, which is impossible to do.

Guessing which stocks to buy is not investing; it’s speculating. The public needs to understand that. So I was pleased that Jon Stewart of the Daily Show took Cramer to task. Since I believe that Jim Cramer’s infotainment gives viewers the absolutely wrong framework for successful investing, I think he got off easy.

ABC This Week with George Stephanopoulos had a roundtable discussing, among other things, whether CNBC fell down on the job covering the financial and business world.

Right at the end of the session, George Will nailed the real issue with his general rules in life.

• Don’t play poker with a man named Slim.
• Don’t buy a Rolex from someone who is out of breath.
• Don’t take financial advice from people who are shouting.

Amen.

CNBC Financial Advice

The Daily Show With Jon Stewart	Mon – Thurs 11p / 10c
CNBC Financial Advice
www.thedailyshow.com
Daily Show Full Episodes Political Humor Healthcare Protests

Last week Jon Stewart of the Daily Show ridiculed the usefulness of financial predictions made on some CNBC shows.  Stewart exposed the theatrics and general silliness of many CNBC commentaries, not to mention the shameful sucking up to CEOs.

Remember that the Daily Show is on Comedy Central, so have a good laugh. This is not meant to be fair and balanced.

Yes, CNBC has had some very good interviews with the likes of investor Warren Buffet, author John Bogle and PIMCO executive and author Mohamed El-Erian. But remember that many CNBC shows are essentially infotainment; they are meant to keep you watching so that CNBC can sell ads.

By the way, keep watching the show to see a humorous but also enlightening interview with New York Times columnist Joe Nocera.

Searching for a Better Investment Guru

U.S. stocks declined yesterday to the lowest prices in more than 12 years. The Standard and Poor’s 500 closed at 700. You would think that now would be a very good time to have a reliable investment guru offer sage advice and words of wisdom. Times are tough, the economy is tanking and there is panic in the streets (Wall Street and Main Street, both). What is an investor to do? Should she buy, sell, hold? “Surely,” you think, “the ‘experts’ must know.” Unfortunately, you’d be thinking wrong; the correct answer is that he or she really doesn’t.

Last month, in an article titled Why the Experts Missed the Crash, Money Magazine published an interview with UC Berkeley Haas Business School professor Philip Tetlock. The professor has spent his career evaluating experts and authorities in a variety of fields, and he is not at all surprised that the vast majority of financial “gurus” failed to predict the recent steep market decline.

Here is a summary of the article:

Despite everything, we can’t shake the belief that elite forecasters know better than the rest of us what the future holds.

The record, unfortunately, proves no such thing. And no one knows that record better than Philip Tetlock, 54, a professor of organizational behavior at the Haas Business School at the University of California-Berkeley. Tetlock is the world’s top expert on, well, top experts. Some 25 years ago, he began an experiment to quantify the forecasting skill of political experts.

Tetlock has analyzed “not just what the experts said but how they thought: how quickly they embraced contrary evidence, for example, or reacted when they were wrong. And wrong they usually were, barely beating out a random forecast generator.”

Why did so many experts miss the economic crash?

The people intimately involved in packaging [financial derivatives like] CDOs must have had some sense that they were unstable. But their superiors seem to have been lulled into complacency, partly because they were making a lot of money very fast and had no motivation to look closer. So greed played a role.

But hubris may have played a bigger one. … In this case the biggest source of hubris was the mathematical models that claimed you could turn iffy loans into investment-grade securities. The models rested on a misplaced faith in the law of large numbers and on wildly miscalculated estimates of the likelihood of a national collapse in real estate. But mathematics has a certain mystique. People get intimidated by it, and no one challenged the models.

Money has written about human mental quirks that lead ordinary folks to make investing mistakes. Do the same lapses affect experts’ judgment?

Of course. Like all of us, experts go wrong when they try to fit simple models to complex situations. (“It’s the Great Depression all over again!”) They go wrong when they leap to judgment or are too slow to change their minds in the face of contrary evidence.

An Alternative to Finding a Better Forecaster

A good part of the article explores the question “What makes some forecasters better than others?” Professor Tetlock has a detailed answer, which makes interesting reading. He recommends looking for “self-critical, eclectic thinkers who were willing to update their beliefs when faced with contrary evidence, were doubtful of grand schemes and were rather modest about their predictive ability.”

But my answer to the same question is radically different. I believe that it is futile to rely on gurus who have been right more often than others. Various “experts” will be right or wrong at different times, and you cannot, regrettably, know in advance when that will be. So if in essence, the future is unknowable, and experts are so unreliable, you need to have a strategy that does not depend on “accurate” forecasts.

No one, yes no one, knows how markets will behave in the short term. Accordingly, my recommended approach has been and continues to be a disciplined long-term strategy. To understand why, it is absolutely necessary to have perspective on financial history:

• There have been many financial crises in the past; none have proven fatal.
• We have experienced a dozen other Bear Markets since World War II.
• Stock prices have rebounded from all previous declines, even steep ones.
• The stock market goes up in roughly 3 out of every 4 years.
• Stock market losses are temporary; stock market gains are permanent.

Furthermore, waiting for the “right time” to invest doesn’t work for most people, most of the time. The likelihood is that you will miss out on the really strong rebounds that happen when you least expect them. In other words, don’t wait until it looks safe to invest in stocks.

Accordingly, I leave forecasting to the “experts” who according to Professor Tetloc “barely beat random guesses – the statistical equivalent of a dart-throwing chimp – and proved no better than predictions of reasonably well-read nonexperts.”

I do believe in controlling what I can:

• Costs (through low cost mutual funds)
• Risk (through global diversification and sensible asset allocation).

I believe in staying the course so as to participate in the eventual and inevitable recovery.

In short, I do not have a forecast; I have a philosophy and an approach. It’s not perfect, nothing in this world is, but experience shows that it works better than any other approach.

Investment Guru Predicted Crash

“There will always be someone predicting disaster and someone predicting great fortune. At one time or another, each will be closer to correct than the other. But it won’t matter to you if you understand this and have invested responsibly. You have a long-term plan; stick with it.” Peter Lynch.

In my previous post, one of the individuals quoted was Jeremy Grantham, a very successful money manager, who has been getting a great deal of media attention lately. He was among the “Fortune Tellers” featured in New York Magazine’s December 7th article, Oracles of Doom.

In addition, late last month, Grantham was the sole guest on PBS’s popular investment program, Consuelo Mack: WealthTrack. She described him as a modern-day “Cassandra,” noting that he predicted today’s depressed stock prices a decade ago.

I might be in the minority here but, in my opinion, being pessimistic 10 years in advance isn’t all that useful.

Now, don’t get me wrong, I think Grantham is very intelligent and quite eloquent. He’s also very convincing. The problem I have with him is that he has been bearish for so long, that eventually, he had to be right.

You can read more about his prophesies in Here Comes the Crash, an article published in the November 15, 2004 Fortune magazine.

Talk to Jeremy Grantham about the stock market, and you get the impression the sky is about to fall. For years the chairman and chief strategist of money-management firm Grantham Mayo Van Otterloo has been gleefully rattling listeners’ nerves with his claim that the excesses of the dot-com bubble still haven’t been unwound and that the market is headed for another precipitous drop. About a year ago his prediction became alarmingly specific. Shortly after this year’s election, he says, the market will sink into a “black hole,” losing about a third of its value over the next two to three years. He sounded this warning most publicly at the annual Morningstar investment conference in July. In late October, speaking from his elegant Boston townhouse, he told FORTUNE, “We’re still in the unraveling of the greatest bull market in American history.”

To be fair, from what was printed in the Fortune article, he has been right:

Using GMO’s computer models, he has made several well-timed calls. In 1982, with stocks selling at fire-sale prices and the economy recovering, he predicted the market was ripe for a “major rally.” That year the U.S. market kicked off its longest bull run ever. He also called the top of the Japanese bubble in 1989, the resurgence of U.S. large caps in 1991, and the rallies in U.S. small-cap and value stocks in 2000.

But, he has also been wrong:

He turned bearish on U.S. equities in the mid-1990s, prompting clients to shift money to other firms.

His prediction in 2004 was that “The low will come two or three years from now, at a level below 700 on the S&P.” That’s not what happened at all. In fact, the S& P 500 went up in 2003, 2004, 2005, 2006 and 2007. Finally, in 2008, his pessimism paid off.

A web site from CXO Advisory Group rates investment “gurus.” According to them:

Jeremy Grantham has been persistently very negative about the prospects for U.S. equities (apparently since 1994), but not for international equities.

Based on subsequent stock market performance and our judgments about his forecasts for overall stock market direction, Jeremy Grantham’s forecast accuracy rate is 48%, which is about average. His forecast sample size is very small, as is our confidence in this score.

Note that carefully: 48%. One could argue that an accuracy rate of 48% is not dissimilar from simply using a coin tossed in the air to determine your prediction.

Finally, if the stock market had gone up this year, I doubt that Jeremy Grantham would be getting this much favorable press.

Experts Who Predicted Recession

“The only function of economic forecasting is to make astrology look respectable.” – John Kenneth Galbraith.

I took a look back through my files to see which market economists or analysts correctly predicted that we would eventually have such an awful recession and horrendous stock market decline. In his article, Last Christmas Before Next Recession, Paul B. Farrell of MarketWatch quotes economists and investment gurus who did not pull their punches. You won’t find a “on the one hand this and on the other hand that” quote among the lot.

Of course, this particular group is always making predictions. So please read the entire post, before you decide how “helpful” their predictions actually were.

The quotes are very slightly shortened (for dramatic effect).

Jeremy Grantham of Grantham, Mayo, Van Otterloo & Co

“Everyone agrees that there are extreme imbalances in the U.S. and the global economy … The bulls believe that all will work out … The bears believe that sooner or later these imbalances will come home to roost. … The probable winning bet [is] a very mean reversal … for the next few years.”

Gary Shilling, economist

“A bursting of the housing bubble will probably be the expansion ender. Signs of the bubble’s demise are accumulating, making a … recession probable.”

Bill Gross of Pimco

“Now after 300 basis points and 17 months of tightening — which by the way is typical of prior bear cycles as well — it should only be logical to expect a slower economy …”

Alan Greenspan

“Our budget position will substantially worsen in the coming years unless major deficit-reducing actions are taken. The consequences for the U.S. economy of doing nothing could be severe.”

Farrell goes on to recommend extreme steps to prepare for the bear market and recession.
“You need a wake up call: Total shift of consciousness, an extreme mental makeover, a massive attitude adjustment. … This is real war.”

He ends with this question, “Are you prepared to survive the recession and bear market likely to hit in 2006?”

Yup. You read that right. That’s 2006. The article was posted on December 12, 2005. Had the article been posted on December 12, 2007 that would have been really impressive. Frankly, being two years early in calling a recession is not at all useful. In point of fact, the S&P 500 had returns of 15.8% in 2006 and 5.5% in 2007.

So, what do you call people who are right, but two years early?

“Wrong.”

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