Intelligent Investing, Part 1

“Instead of concentrating on the central issue of creating sensible long-term asset-allocation targets, investors too frequently focus on the unproductive diversions of security selection and market timing.” – David Swensen, chief investment officer of Yale University.

To many people, investing can seem a bit like a game of chance. Tracking the daily fluctuations in the equity markets can make it difficult (some might say impossible) to make any sense of investing.

Turn on the television to learn about the stock market, and too often, what you will find is talking heads.  They are no help; they are misleading, because they generally  speak only of the short term. These TV stock market commentators are always predicting future prices for stocks, bonds, currencies, etc.  It doesn’t matter if they disagree (which they regularly do, since it makes for more interesting conversation) or whether one or another turns out to be correct or way off. You never hear how their predictions turned out.

A Better Way

Modern Portfolio Theory (MPT) is a very different approach to investing. It does not depend on predicting the future or analyzing individual stocks. It is based on decades of academic research. In fact, several individuals have won Nobel prizes as a result of their discoveries related to the way securities markets work. MPT has also influenced the way many pension funds and college endowments are invested, including Yale’s.

Think of Modern Portfolio Theory’s message as the opposite of what Wall Street wants you to believe, which is that their analysts have the secret to successful investing through superior stock selection.

For a good solid introduction to the practical implications of Modern Portfolio Theory, you can view Henry Blodget’s recent interviews with Ken French, Professor of Finance at the Tuck School of Business at Dartmouth College.

The first video is Buy and Hold Versus Timing the Market.

The second video is Stock Picking Versus Index Investing.

Each video is about 5 minutes long.

Dimensional Fund Advisors

Ken French is not merely a prolific academic researcher; he is also the Director of Investment Strategy for Dimensional Fund Advisors (DFA). DFA applies academic research on capital market behavior to the practical world of managing investment portfolios. The firm maintains close ties with the University of Chicago and other research centers for financial economics.

DFA’s approach is firmly rooted in the belief that markets are “efficient,” and that investors’ returns are determined primarily by asset allocation decisions, not market timing or stock picking. DFA has no economists forecasting business cycles or interest rates, no investment strategists shifting allocations between stocks and bonds, and no analysts seeking “underpriced” stocks.

With $140 billion under management, Dimensional Fund Advisors is the leading provider of structured investment strategies in the world. DFA funds are carefully constructed to capture the returns of a well-defined asset class that has historically provided investors with a substantial premium for the risks those investors took.

DFA funds are only available to institutional investors and through a select group of fee-only financial advisors who subscribe to the passive asset class investment philosophy.

Along with other select funds, I recommend DFA funds be included in my client portfolios.

Are We Nearer To A Market Bottom?

Milo Benningfield, a fee-only Certified Financial Planner in San Francisco, asks a very good question – Are we closer to the stock market bottom, now that some well-known pundits have turned bearish?

Huh? Market “experts” are worried, so we should get ready to BUY stocks?

To the novice, this may seem perverse, but some stock market observers believe that when “everyone” has become bearish, there is no one left to sell “at any price.” Therefore when “everyone” is fearful, the stock market is likely to go up. So “negative sentiment” is bullish, and vice versa, at least at the extremes (at turning points).

I am obviously delving into the dangerous area of technical analysis by even considering whether stock market sentiment can be an indicator of the future direction of prices. As far as I know, there is no independent academic research showing that this approach results in improved investors’ returns.

For most people, at most times, a buy-and-hold strategy works just fine. And when you think, “this time is different” you are just as likely to be wrong.

On the other hand, I can’t resist.  I simply find this line of thinking fascinating, so here is Benningfield’s post, Pundits Capitulating — Are We Nearer To A Market Bottom?

After months of good-faith efforts to bolster investors’ spirits, several prominent financial journalists threw in the towel this week and turned gloomy. The pundits, at least, are capitulating. Could this mean we’re closer to a market bottom?

Example 1 — Ben Stein
Back in the summer of 2007, after the first wave of the credit crisis hit, New York Times columnist Ben Stein told us the market sell-offs were “nutty,” since “This economy is extremely strong. Profits are superb. The world economy is exploding with growth.”

Over ensuing months, while acknowledging the steady stream of poor economic news, Mr. Stein continued to maintain an upbeat attitude, encouraging investors not to panic and telling them “this big, strong economy will sail on through.” That changed this week. Mr. Stein asks, “What if a slowdown is a never-ending story?” His column raises the specter of a depression, telling us, “This time it’s different . . . The problem now, as in 1929 to 1940, is that the economy is not functioning normally.”

Example 2 — Jason Zweig
Wall Street Journal columnist Jason Zweig has done a valiant job these past several months urging investors to avoid panic and to see the silver lining that has emerged with cheaper stock prices and higher expected returns.

But this week, he, too, turned to the Great Depression in his Wall Street Journal column, “1931 and 2008: Will Market History Repeat Itself?” In the gloomiest terms I’ve ever read from him, Mr. Zweig warned us:

“It is vital to realize that markets are never under some obligation to stop falling merely because they have already fallen by an ungodly amount. It also is vital to explore how bad the worst-case scenario can get and to think about how you would respond if it comes to pass.”

Example 3 — Floyd Norris
The chief financial correspondent for the New York Times, Mr. Norris has done a great job reporting on the credit crisis and, unlike many shyer souls, has been willing to stand up and be counted with his predictions for where a market bottom will likely be found. Not this week. As Mr. Norris put it in his blog, “P.S. I am following the suggestion of several commentators on this blog. I am giving up on trying to identify a market bottom.”

Market bottoms typically require a “capitulation” where the vast majority of investors finally sell most of their assets and walk away in disgust. By many measures, we’re not there yet (and may not be for months). But pundits capitulating is at least a good start.

Nice job, Milo.  I have added your blog Margin of Safety to my list of recommended blogs.

Investor Capitulation, Part 3

“Bear markets sometimes end with a bang, sometimes with a whimper. You’re more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation.” – Jason Zweig.

Of late, I have been writing about the possibility that the current stock market decline could end with a great big bang, followed shortly thereafter by investor disgust and despondency. It’s more of an intellectual exercise, because I am basically an agnostic on the subject. Frankly, no one really knows whether or not we will have such a “selling climax.”

Jason Zweig’s Intelligent Investor post on October 25 is called Capitulation: When the Market Throws in the Towel. Surprisingly, Bear Markets Don’t Always End With a Bang — Sometimes It’s Just a Whimper. His point of view is worth reading and emphasizes that we just never know what will happen.

There’s a belief that the market can hit bottom only when vast numbers of investors finally capitulate, throwing in the towel and selling off the last of their stock portfolios. In theory, if you could spot this moment, you could make a killing buying at the bottom.

There are two problems here. First, capitulation is almost impossible to define. Second, even if you could get a positive ID on capitulation, that might not do you any good. Market lows aren’t necessarily marked by tidal waves of frantic selling; just as frequently, stocks bottom out in a dull and lonely atmosphere as trading dries up and most investors no longer even care. Bear markets often end not in capitulation but stupefaction.

Oddly, even market pundits who believe in capitulation admit they can’t define it. “Capitulation is a state of mind, without any specific definition,” says Al Goldman, chief market strategist for Wachovia Securities. “You can’t measure it; it’s best identified in hindsight.” Hugh A. Johnson, chief investment officer at Johnson Illington Advisors, says almost wistfully: “I wish I could quantify it for you so I could say, ‘Here, this is capitulation.’ But a lot of this is anecdotal. Talk to enough investors and you get an idea of whether we have capitulation.”

“The most interesting thing about [the 1974 market bottom] was its dullness,” veteran fund manager Ralph Wanger recalled to me. “It wasn’t a crash, it was a mudslide. You came in, watched the market go down a few points and went home. The next day you went through the same thing all over again.” And then, without a moment’s warning, the bull woke up and took off. By Jan. 6, 1975, the market had shot up 10%, and a year after that the Dow had risen 54% from its 1974 low.

In short, bear markets sometimes end with a bang, sometimes with a whimper. You’re more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation.

Conclusion

The obsessive attention so many investors are paying to the huge swings in the Dow suggests that we may not have hit bottom yet; stupefaction seems not to have set in yet. What we can be quite certain of, however, is that stock markets around the world are already on sale. If you have cash to spare, put some to work. If you don’t, save up until you do. But don’t kid yourself into thinking that you will ever get a clear signal out of such an unclear indicator.

I sincerely hope that my posts have not added to the “obsessive attention” to the stock market swings. I believe that when an investor owns, even a single share of stock, he actually owns a share in a business. A share of stock is not like a lottery ticket, and it’s more than just a piece of paper based on numbers that crawl across the bottom of a TV screen.

As providers of capital, investors are entitled to a return. In the short term, returns can vary tremendously. Historically, over the long term, stocks have returned more than safer investments.

As for the short term, i.e. what we are living through now, there are dramatic factors that have been causing stock prices to decline – specifically, margin calls and hedge fund redemptions.

An example of a margin call is a company’s CEO who had earlier borrowed money to exercise company stock options. Because the company’s stock price has since declined in value, the CEO must either put up more capital or sell the stock in the account to meet the broker’s margin requirement.

Hedge funds have been selling stocks, currencies, commodities – basically whatever they could sell – to prepare for imminent redemptions. This is, in effect, “forced selling,” similar to margin calls. And there is just no way to know when this will all end.

Since everyone knows this, it is possible that stock prices already reflect the negative situation. If that’s the case, this could be a great “buying opportunity” for stocks. Unfortunately, we will only know if we were right in retrospect.

photo credit: erin MC hammer

The Cloudy Crystal Ball, Part 6

 

 

“These types of forecasts are wildly off-base. What they’re always about is extrapolation. People are always extrapolating recent trends. And you don’t know how far the trend is going to really run.” – William A. Fleckenstein.

This post is a continuation of articles on how no one can predict the stock market or any other market, for that matter.

Going for the Gold in Gloom and Doom by Michael M. Grynbaum has an analysis of the phenomenon of people who make predcitions that are extreme.  They not only confidently assert their forecasts, but they are frequently wrong.  And they are not held accountable for their mistakes.

“Financial forecasters are in a race to call the bottom to the bear market. And just as on the way up, when analysts competed for attention with their forecasts of bigger and bigger gains, the financial pundit class now seems compelled to out-gloom the next guy.

“To make a crazy forecast today is not crazy,” said Owen Lamont, a former professor at Yale who has studied economic forecasting. “It’s not crazy to predict the Dow is going to 2,000. That’s in the realm of possibility.”

“Even in normal times, forecasters have a strong incentive to make extreme predictions, which is why those “Dow 1,000!” reports persist. “It’s eye-popping. It’s relevant. It seems exciting,” Mr. Lamont said. Such predictions attract publicity, name recognition and a bigger client base in a business where investors pay thousands, if not millions, for stock advice and investment guidance.

And even if a forecast is off-base, there are few repercussions because they are almost always quickly forgotten. “The reason that people do these games is because no one’s really tracking accuracy,” said Mr. Lamont, who now works at DKR Capital, a hedge fund in Greenwich, Conn. “No one is carefully, prudently giving more business to the guy who is 2 percent more accurate than the next guy.”

Some say this is a system that propagates ignorance and poor advice.

“Anyone that invests 10 cents on the basis of someone’s forecast of the Dow is desirous of losing a good portion of their 10 cents,” said William A. Fleckenstein, president of Fleckenstein Capital, a money management firm in Issaquah, Wash. “It is almost the height of arrogance to say this is where the Dow is going to trade.”

“These types of forecasts are wildly off-base,” Mr. Fleckenstein said. “What they’re always about is extrapolation. People are always extrapolating recent trends. And you don’t know how far the trend is going to really run.”

Some financial pundits, however, are all too happy to broadcast their predictions to the public, no matter how apocalyptic.

Peter Schiff, the president of Euro Pacific Capital in Darien, Conn., and a prominent financial Cassandra, has seen some of his most dire forecasts confirmed amid this year’s turmoil. On Friday, he predicted plenty more pain to come.

Forecasters who get too far ahead of themselves would do well to remember an instance of notoriously poor prognostication. One of the few times that a financial strategist has been widely taken to task came in 1999, when Kevin A. Hassett and James K. Glassman published “Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market.”

The book, which arrived just months before the technology bubble burst and stocks plummeted to earth, was actually an argument that bonds and stocks should be considered as equally risky investments. But the title — cartoonish in hindsight and, in its authors’ defense, proposed by the publisher — has since become a popular punch line for jokes about irrational exuberance in turn-of-the-century Wall Street. (The Dow closed on Friday at 8,378.95).

Still, while the reputation of its authors may have taken a hit, “Dow 36,000” has not seemed to hurt their careers.

If you had taken their book seriously, you would be much poorer.  But while their predictions were way off the mark, both authors have done just fine.  One has a prestigious position with the American Enterprise Institute and one with the Bush Administration. 

Conclusion

Wildly optimistic forecasts and wildly pessimistic predictions are often wrong. Frequently the prognosticators are merely extrapolating the recent past. The main thing they accomplish is to gain attention for themselves. If you listen to such predictions and act on them, you do so at your own risk.

Investor Capitulation, Part 2

“The most common cause of low prices is pessimism – some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.” – Warren Buffet.

In a previous post, I raised the possibility that we might witness a kind of panic selling called capitulation. This was not meant to be a prediction. It was an observation that sometimes a bear market ends in a very sharp decline, and it is generally associated with investors’ extreme discouragement and/or disgust. This is not an exact science, but more like Justice Potter Stewart’s comment on pornography – you’ll know it when you see it.

Well at 7:30 this morning, the futures markets indicate a very weak opening for U.S. stocks. This is happening after markets had steep declines in Asia, with the Japanese stock market falling almost 10%. European stocks have also declined by 7-10%. Right now it looks like we are going to have a “Terrible, Horrible, No Good, Very Bad Day.” (Judith Viorst) Of course, no one knows where the market will close today or what will happen next week.

For more context, Mark Hulbert’s column Anatomy of a Bottom, written for MarketWatch on October 21st, describes the difference between a “Panic” and “Capitulation.”

Capitulation has a number of distinguishing psychological characteristics, such as investor disgust and exhaustion. Having been burned by the market for so long, investors capitulate by resolving never, ever, to trust the market again.

In the wake of capitulation, therefore, interest in the market declines. Apathy rules.

To be sure, this definition cannot be mechanically measured. It is hard to pinpoint when investors become maximally dejected and apathetic. But my hunch is that we have yet to experience capitulation.

One illustration of capitulation that I find particularly instructive, even though it is from a pre-Internet era: During bull markets, as well as during bear markets up until capitulation finally occurs, investors turn to the business sections of their morning newspapers to see how much they made or lost the previous day. At times of capitulation, in contrast, investors don’t even bother to open the business section at all.

From the perspective of this illustration as well, capitulation is yet to occur: Far from being ignored, business news is now splashed all over the front pages of newspapers’ lead sections.

My guess is that, when that low does finally occur, we’ll be witnessing, and experiencing ourselves, a lot more of the psychological traits associated with capitulation: Exhaustion, disgust, lack of interest, even apathy.

Interpretation and Advice

Investors, by definition, are “in it for the long run.” If the recent events on Wall Street, and indeed, across the globe, have you so discouraged that you question whether stocks really do provide higher returns than bank CDs, then you are in the grips of capitulation. How you behave or how you react, at this moment, will be what determines your rate of return for a long time to come.

If you sell when everyone else is selling, you may get some immediate psychological comfort that you have come in out of the storm. My belief, which is based on extensive experience, is that you will do yourself harm in the long run.

What happens to stock prices in the short term is anyone’s guess, but if investors are not rewarded for taking risk by investing in stocks, capitalism cannot function.

photo credit: JdeePanIII

Investor Capitulation, Part 1

“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” – Warren Buffett.

I do not believe in the concept of market timing, because no one knows what the short term direction of the stock market will be. An educated guess is about the best anyone can make. That is why a buy and hold strategy, using a well diversified portfolio, works best for most investors.

Given their own, sometimes naïve, perceptions, investors can become either too optimistic or too pessimistic. Unfortunately, it is typically easier to identify these times after the fact.

It is very easy to make predictions that turn out wrong, even if you are very knowledgeable.

For example, former Federal Reserve Chairman Alan Greenspan warned about “irrational exuberance” in 1996. He clearly thought that the high stock prices of 1996 could not be justified. Nevertheless, the stock market went up in 1996, 1997, 1998 and 1999. Eventually, in March of 2000, stock prices began their steep decline. Needless to say, if you had heeded “Financial Guru” Greenspan’s warning in 1996, you would have lost out on 3 – 4 years of profitable gains.

In October 2002, after stock prices had fallen almost 50% from their previous highs, a lot of investors “threw in the towel” and basically gave up on stocks. They sold their holdings and stayed out of the stock market for several years. Many of those investors compounded their mistake by switching from equity mutual funds to variable annuities. (That is a topic for another post.)

Let’s assume that, right now, given the current economic climate, the majority of investors are pretty pessimistic about the future. How can we tell? There have been plenty of indicators. Stock prices have already declined more than 35% from their year-ago highs. Banks have been afraid to lend to each other. Institutional investors (pensions, university endowments) have been pulling massive amounts of money out of hedge funds. Many individual investors have been heavily selling mutual funds. And many people, and institutions, have flocked to short-term Treasury securities,  because they are known to be extremely safe investments, albeit very low yielding ones.

Now, suppose stock prices continue to fall, resulting in investors becoming even more pessimistic than they already are. How could this happen? Well, what if so many investors decided to redeem their accounts that hedge funds needed to sell off even larger amounts of stocks, bonds, and commodities just to fulfill the investors’ demands. What if individual investors continued to sell their stocks and mutual funds, only doing it in greater amounts and with far more urgency?

Panic Versus Capitulation

What is this called? Well, panic is one term. Capitulation would be another. You may be hearing this particular term more often now. What would capitulation look like? Probably like the end of the world. The Dow Jones Industrial Average would fall by 800 – 1,000 points or more in a single day. And just suppose that that the selloff continued for a second day. Imagine the ominous discussion on TV. Investors would feel discouraged, disgusted and positively sick. One reaction might be, “Get me out now, at any price!”

If that happens, and there are certainly no assurances that it won’t, then this may in fact be the best possible time to buy more stock. Of course, it is very difficult to even consider buying when prices are actually plummeting and everyone is afraid. (You should note that it is incorrect to say that there are “more sellers than buyers.” In point of fact, there is a buyer for every seller, or more aptly put, each share to be sold will be bought. It is just that the sellers are willing to accept lower stock prices than previously was the case.)

I do not know if the capitulation phase of the bear market will occur. In Prepare for the Revulsion Stage  Janice Dorn, Chief Global Risk Strategist, Ingenieux Wealth Management, Sydney, Australia predicts that capitulation of investors will probably happen. Here’s how she envisions it.

Now, we are likely to see a washout where just about everyone who has not sold will give up and sell. They will walk away from the markets and vow never to return again. This will be the complete revulsion stage. Only when this happens will the markets be in a position to begin to rebuild the technical damage. This will take time, and it now appears that the highs in the broad indices have been seen for many years to come.

People will have nightmares about the Great Crash of 2008 for years to come. They will lose trust in the entire financial system and in many of their advisors who allowed their accounts to lose somewhere between 25% and 50%. The small retail trader will leave the markets in disgust and distrust.

Dorn’s description is quite graphic. And she is saying that it is likely to happen. Make no mistake, she is predicting a once-in-a-generation change in investor perception. We’ll see if this extreme reaction comes to pass.

But please remember that stock market lows can only be identified in retrospect. Moreover, for people who follow a buy and hold approach, all of this may be of only intellectual interest. On the other hand, knowing that this kind of panic behavior can happen may steel you not to join the herd in selling at what may just be the wrong time.

photo credit: Bitterroot

The Cloudy Crystal Ball, Part 5

“The only way to make money with a (market timing) newsletter is by selling one.” - Malcolm Forbes.

Market-Timing Newsletters

No one can accurately predict the short term direction of the stock, bond, oil or any other market, but you can do quite well by charging money for those predictions. Many people buy newsletters that will help them to determine whether or not now is “a good time to invest.” Let me ask you, if you were able to do that, predict the markets accurately and consistently, would you share that extremely valuable information?

Yes, newsletter writers are very convincing, whether they quote economic reasons or technical factors based on the internal dynamics of the stock market. Yes, they use data and systems that you don’t have access to or wouldn’t understand unless you had taken classes to learn them. They talk about or refer to chart patterns, oscillation, On-Balance Volume, etc.

Oh, they speak with great conviction. And when they are wrong (and they are often wrong), they write convincingly why that happened the way it did. They may place the blame on their “system” or their (mis)interpretation of their system. Great stuff.

In fact, thousands of people subscribe to such predictive newsletters. There’s even a paid service that evaluates the newsletters for you, The Hulbert Financial Digest. As for a track record, many newsletters go out of business within a few years. Some will have success in the short term, maybe as a result of skilled, knowledgeable writers, but more likely, it’s just plain dumb luck.

One such prognosticator is the famous (or infamous, depending on your point of view) Joe Granville. I remember back in the 1980’s when his forecasts could literally move markets.

Here is a recent article from MarketWatch.com indicating that Granville had turned bullish, i.e. he expects stock prices to go up. Read more

The Cloudy Crystal Ball, Part 4

“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.

A Recipe for a Beguiling Article

Creating a recipe for a column about the predictions of market gurus is an interesting task. You need people with a good track record, with different takes on which way the market is going. And most of all you need colorful language and good quotes.

As a recent example, take Jonathan Burton’s article in MarketWatch, The Four Horsemen of the Market: Heed the sobering investment advice of these veteran money managers.

Perhaps calling them “Four Horsemen” is a bit heavy on the sauce, but Burton serves up quite a dish. This particular column calls for two parts pessimism and a cup of caution. Add a dash of optimism for balance. Voila, a prediction column! And it really does not matter if the investment strategists are right about predicting the future. In a few weeks, get some new “experts” with different opinions. The recipe stays the same; only the ingredients change.

Well, if nothing else, the money managers certainly provide interesting, “insightful” analysis and very colorful quotes! But since they disagree on the best strategy, I am not sure how you could “heed” these “experts.” You would certainly get indigestion. I definitely do not recommend that you accept their market timing approach, or anyone else’s for that matter. A previous post explains why investing in the equity market should not be dependent on a prediction of the short-term direction of equity prices.

A Gaggle of Gurus

In any event, here are some of the best quotes:

Jeremy Grantham is “Officially scared.”

“The fundamentals have turned out to be worse than I had thought,” Grantham said. “My advice would be, don’t take any risk.”

“I underestimated in almost every way how badly economic and financial fundamentals would turn out,” Grantham wrote shareholders in a July letter. “Events must now be disturbing to everyone, and I for one am officially scared!”

John Hussman says, “Stay defensive.”

“The stock, bond and foreign-exchange markets continue to trade essentially on the theme that the global economy is weakening, but that the U.S. has dodged a recession,” Hussman wrote in his weekly market commentary in late August.

Investors’ consensus is mistaken, Hussman contends. He said the U.S. is mired in recession, and once investors realize that earnings expectations are overblown, stocks will take another major hit.

“The potential downside could be abrupt, leaving little opportunity to make defensive changes after the fact,” Hussman wrote.

Bob Rodriguez is on a “Buyer’s strike”
He declined to be interviewed for the article but was described as continuing “to focus on caution and capital preservation.”

Steve Leuthold is “Pretty positive.”

Like Hussman, Leuthold is convinced that the U.S. economy is in recession. But he points out that the stock market typically bottoms around the midpoint of the downturn. By his reckoning, the economy entered recession toward the end of 2007, and the extensive valuation criteria he uses tell him there’s now light at the end of the tunnel.

“The bottom has been made,” Leuthold said. “The economy is going to start showing some positive signs sometime in the first half of 2009.”

So he’s getting in early, loading up on shares of biotechnology and alternative-energy companies in particular, and keeping a modest amount in oil drillers and natural gas producers.

Conclusion

These “experts” disagree, which is not surprising. There is no evidence that anyone can predict the course of the market. So let’s face it: No one knows whether, in the short term, the stock market will sink or soar. But we do know that the long term trend has been up for stock prices.

Judging by his recent column on how to evaluate 401(k) choices, Jonathan Burton is a very good journalist. But this “prediction” column does not serve his readers well. It fosters the mistaken belief that in order to be a successful investor you need someone to predict the future for you. That’s just not true.

It is not necessary to try to predict market prices, since a buy-and-hold approach works quite well over the long term. Now that’s a recipe for success.

It just doesn’t make for a very scintillating column.

Buy and hold is a very dull strategy. It lacks pizzazz and doesn’t inspire much admiration at cocktail parties. It has only one little advantage: It works, very profitably and very consistently. – Frank Armstrong

The Cloudy Crystal Ball, Part 3

“You have to keep reminding yourself. We don’t know what’s going to happen with anything, ever.” – Peter Bernstein

Ignore this prediction!

Yesterday’s Wall Street Journal had a very pessimistic “Abreast of the Market” entitled There’s Always Next Year: Hopes Fade for Second-Half Stock Rally As Credit Crunch, Weak Earnings Persist.

For those of you without a newspaper or online subscription to the WSJ, here are some relevant quotes:

“Hopes have all but faded among investors that the stock market will be able to mount a much-anticipated second-half comeback.

Many now think a sustained rebound for stocks may not be in the cards until the middle of next year. Even then, their expectations are limited as the problems in the financial markets continue to spread rather than ease.”

“‘Earlier in the year, we had hoped that the economy would see an uptick in the second half,” and stocks could rally, said Robert Pavlik, chief investment officer at Oaktree Asset Management, which manages some $350 million. Now, he characterizes his outlook for the stock market through the rest of 2008 as “gloomy” and hopes for “some kind of modest recovery in 2009.”

“We just can’t make a case for a sudden bull market or a sudden economic surge,” said Neil Hokanson, a Solana Beach, Calif., financial adviser with client assets of $330 million.

“It’s hard to say what the next leadership could be for the market,” said Linda Duessel, a stock strategist at Federated Investors. With all the crosscurrents, “we’re talking about a sideways market” for the remainder of the year, she said.

Convinced? These “experts” believe that the stock market is going nowhere for at least the next six months. But let’s think about this analysis. What do these strategists know that isn’t already known? Probably not much. And can they predict the future any better than anyone else can predict the future? No, probably not.

So, why pay any attention to them? Good question. Here are words of wisdom from William Bernstein, author of The Four Pillars of Investing:

“It is said that there are only two kinds of investors: those who don’t know where the market is going, and those who don’t know that they don’t know. But there is a rather pathetic third kind – the market strategist. These highly visible brokerage house executives are articulate, highly paid, usually attractive, and invariably well-tailored. Their job is to convince the investing public that their firm can divine the market’s moves through a careful analysis of economic, political, and investment data. But at the end of the day, they only know two things: First, like everybody else, they don’t know where the market is headed tomorrow. And second, that their livelihood depends upon appearing to know.”

To be continued …

The Cloudy Crystal Ball, Part 2

“We have two classes of forecasters: those who don’t know — and those who don’t know they don’t know.” – John Kenneth Galbraith

Politics and the Stock Market

Forget about the issues, the upcoming presidential debates, or even voter turnout. Why even bother to vote, when the stock market can tell us who will win?

An article posted today on the CNBC website, ”Who’s the Next President? The Stock Market Says…” gives us an “analysis” of the upcoming presidential election. The article’s writer bases his analysis on the Stock Trader’s Almanac and Standard & Poor’s, publications that are more commonly used to make predictions and comment on stock market trends. It’s a very entertaining article, but has no informative value in helping you to become a more successful investor. The following quote is very revealing:

“Presidential election years are usually good for stocks, no matter which party wins, while the market’s performance in the three months prior to the November vote is a reliable indicator of which candidate wins.”

Well, so far 2008 has not exactly been a banner year for the stock market, so the first part of that quote has been shot full of holes. But consider this, suppose that you had taken this “prediction” to heart and invested 100% of your capital in stocks in January, instead of following your well thought out investment plan? Where would you be now?

The tail end of that quote tells us who the likely winner will be in the presidential election, depending on whether the stock market is up or down over the next couple of months. This is a very limited view of what economic factors may influence voter behavior — the rate of inflation, the unemployment rate, not to mention the popularity of the present administration, surely all play a part. Certainly using just one indicator – the stock market – is misleading at best.

The article also attempts to give some guidance on how well the stock market will perform, depending on who actually wins in November.

Try to make sense of any of the analysis, if you can, whether you are a short-term trader or a long-term investor. But, please, don’t take anything in this article too seriously. These type of forecasts work, unless they don’t. It is all just “noise.”

And, please, do vote.

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