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.”

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.

The Economy and the Stock Market

“Something that everyone knows isn’t worth knowing.” – Bernard Baruch. 

Baruch was referring to individual stocks, but I take his meaning to include the economy and “the stock market” as a whole. If something is already known, it will have no further influence on individual stocks or the stock market. It is only something new that will affect prices.

Larry Swedroe is the co-author of The Only Guide to Alternative Investments You’ll Ever Need.

In a recent interview with HardAssetsInvestor.com, he talked about commodities, portfolio construction and investing strategy. He also related his outlook for the U.S. economy as a whole to his view on future returns in the stock market. Surprisingly, he is optimistic.

I know, firsthand, that a great many investors are discouraged and/or disgusted with the downturn in the economy, in general, and the decline in the markets, specifically, over the past months. Some investors have fled the stock market for safer investments. And, yes, I realize that it is difficult to find any silver lining in the current dark clouds of the economy.

Certainly, the volatility of the stock market cannot make anyone feel peaceful. It’s clear that optimism is in short supply.

Nevertheless, Swedroe thinks this may be a good time to invest in stocks. Please, consider his logic, which I personally find very persuasive.

HardAssetsInvestor.com: What are your general thoughts about the economy and the stock market here?

Swedroe: The big picture is simply this: Clearly, this is the worst economic crisis we’ve seen since the Great Depression. But wait … did I tell you anything you didn’t already know? The markets know that too. This is the worst market since the Great Depression.

We all know the economic news is going to get worse. Unemployment is going to go up; retail sales are going to go down. But while everyone’s focusing on the bad economic news, they’re forgetting that the market has already understood this.

People are saying, why can’t this be another Great Depression? And it could; you can’t rule that out. But what people fail to understand is this: In the Great Depression, the policy responses were all in the wrong direction. We raised taxes and raised interest rates, increased margin and reserve requirements, and started a trade war. The policy responses this time, whether you agree with them or not, have not only been in the right direction – cutting interest rates, flooding the markets with liquidity, etc. – but they have been the most massive effort ever.

The effort is coordinated around the globe, and countries are pledging to maintain free trade. Every major country is enacting fiscal stimulus programs, all the central banks are cutting interest rates, etc. So while we have had a massive economic crisis, offsetting that are the largest policy responses in history coordinated around the globe. Policy responses take a while to work through the system, while the economic news will continue to look bad for a while.

Remember: Just when things look darkest, stocks tend to have good returns. Prior to this year, when consumer confidence has fallen below 50, the average return for stocks the next year was 16%.

Or consider this: When the unemployment rate is below 4.3%, the average return to stocks is 2%. When the unemployment rate is over 6%, the average return to stocks is 15%.

In the 11 recessions in the post-war era, the cumulative return to stocks is up 7%, and T-bills are up 5%. Returns were positive and better than the risk-free rate. Every time an investor sold stocks and paid taxes, they would have been better off sitting pat in stocks. The only way to do better would have been to forecast the recession, and who can do that?

I cannot guarantee that we will get out of this crisis, but we have gotten out of every other crisis quite well.

(Emphasis added)

Conclusion

Certainly, there is no shortage of bad economic news: Home prices are falling, unemployment is rising, the stock market has had one of its worst years on record, and the automobile industry is asking the federal government for bailouts, like the financial services industry before them. Where will it all end? Is there any good news?

Indeed. Unfortunately, we do not know when the good news will arrive. But, what we do know is that whatever negative that can be said about the economy is already known. If it is widely known, then the bad news is already reflected in current stock prices.

If history has any relevance, and I think it does, after a stock market decline, when pessimism is commonplace, is a very good time to expect stocks to have higher returns.

This may be counterintuitive, but it is true, historically.

How Bad Is This Bear Market?

“Technically, a bear market is when stocks fall 20% or more from their highs. But there’s a saying that a bear’s true signature is making a fool out of everyone. Based on that, we’re all laughingstocks, because there has been virtually no way to avoid this bear market’s claws.” – Matt Krantz.

An article in today’s edition of USA Today, Bear Market Swipes at More Than Just Stocks by Matt Krantz, spells out just how bad the markets have been this year. Here is a summary:

Following a 445-point slide to 7552 Thursday, the Dow Jones industrial average is down more than 6,600 points from its high. The broad stock market is at it lowest level in 11½ years, with the Standard & Poor’s 500 index off 52% from its high in October 2007 and on pace for its worst year ever, S&P says. Only 13 of its 500 stocks are not down for the year, and more than 100 trade for less than $10 a share.

The pain extends far beyond stocks. Oil has crashed 66% from its record close in early July. Even the so-called safe harbor of gold is down 25.5% from its high in March.

This bear has trashed nearly every investment strategy and asset class. It has humbled some of the most powerful names in the stock market and blown holes through long-held tenets in investing. Market historians strain to think of previous bear markets that have disproved so many investing philosophies at the same time.

“There is nowhere to run and hide,” says Ken Winans of investment management firm Winans International. “You have gotten bludgeoned in every direction.”

The extent of the earth that’s been scorched is breathtaking. Brand-name investors such as Warren Buffett, Carl Icahn and T. Boone Pickens have suffered massive losses. Do-no-wrong mutual fund managers, such as Legg Mason’s Bill Miller, are down big. Hedge funds run by managers once thought to be infallible are having their worst years ever.

Even investors who saw the bear coming have been mauled. Those that rushed into commodities or foreign currencies to sit out problems with the U.S. economy have suffered massive losses.

The pros are struggling

Even investors who’ve sought professional help have been stung. Money poured into mutual funds, hedge funds and private-equity firms run by experts known for out-foxing markets in good times and bad. The bear has proved to be smarter than the fox.

Legg Mason’s Value fund (LMVTX), famous for the longest streak beating the S&P 500 under the leadership of portfolio manager Miller, is struggling. It is down more than 65% this year, the third year in a row that it has lagged behind the market. It now has just a one-star rating, out of a possible five, from Morningstar.

Eddie Lampert, the hedge fund manager for celebrities such as David Geffen and Michael Dell who was routinely compared with Warren Buffett just a few years ago, has seen his investments sour. His personal worth has fallen to $2 billion from $4.5 billion just two years ago, Forbes says. His hedge funds’ biggest investment, Sears Holdings (SHLD), has collapsed 70.5% this year.

Speaking of Buffett, the bear snagged the Oracle of Omaha, too. … Buffett’s personal worth is getting mauled, too. Forbes estimated his net worth at $62 billion in February, but that is based mostly on his large holdings of Berkshire Hathaway stock, which is now down $74,150, or 49%, from its high of $151,650 a share.

Commodities aren’t shelter

Investors who thought they saw the stock crash coming figured they had the answer: commodities. Fears of inflation and economic problems pushed many investors into gold. An ounce of gold soared 53.6% in the year leading up to its peak on March 18 as investors poured in. But investors who piled into gold in March have been dealt a 25.5% loss.

A similar story with oil. The price of crude was soaring earlier this year, and gas prices were a national fixation. At the closing peak of $145.29 a barrel on July 3, crude was up 51% for the year. With predictions of it hitting $200 or more, it seemed like a can’t-lose proposition. Speculators lost and lost big as the price crashed nearly $100 a barrel to about $49 now.

The Reuters/Jefferies CRB index of 19 raw materials dropped more than 4% Thursday, hitting its lowest level since April 29, 2003, according to Bloomberg News.

Global diversification is making things worse

We’ve heard it before. Own both U.S. and foreign stocks, and your portfolio’s ups and downs will be moderated. When domestic stocks zig, foreign stocks are supposed to zag.
But that hasn’t worked either. The iShares MSCI EAFE index fund (EFA), which tracks stocks in developed nations in Europe, Asia and the Far East is down 54.5% this year. That’s worse than U.S. stocks’ decline.

What about emerging markets stocks? Up-and-coming nations such as China, Brazil and India were supposed to be growing fast independent of the U.S. Well, the iShares MSCI Emerging Markets (EEM) index has fared worse, tanking 64%. Every major nation’s stock market is down this year, says S&P’s Capital IQ.

Buy-and-hold investors are getting hurt

Buy-and-hold investors know short-term swings are normal. They hold through tough times, knowing returns come to those who wait. But investors who invested in the S&P 500 10 years ago have seen the value of their stocks decline 35%. Even investors who used dollar-cost averaging and invested $500 a month starting Dec. 31, 1996, and reinvested dividends lost $13,225, or 17%, as of Oct. 31, says Winans.

Bonds are eating away at portfolios

Rather than buffering losses on stocks, corporate bonds are falling apart. The iShares iBoxx Investment Grade Corporate Bond fund (LQD), which invests in bonds with high credit ratings, has a negative return of 14.4% this year. That may not sound that bad, except investors buy bonds because they want very little volatility.

Sam Stovall of S&P says that it’s usually not wise to give up on investing in the depths of a bear market. While it takes five years on average for investors to get their money back after a 40%-plus decline, those who keep investing when stocks are cheaper are made whole faster.

Conclusion

A small point: The article overstates the damage to bond investments. Not all have suffered. In fact, Treasury securities have done quite well this year, as investors have fled to these very safe investments. (As the yield of a bond goes down, the price of the bond goes up.)

But the article is generally correct. Unless the stock market recovers from these low levels, which certainly could still happen, 2008 will go down in history as the worst year ever, as measured by the Standard and Poor’s 500 Index. I believe, though, that this is not the time to get discouraged and abandon your well thought out portfolio. In this instance, doing nothing is preferable to selling everything.

There are some opportunities out there. If you can do it, this is a good time to convert your traditional IRA to a Roth IRA. It might also be a good time to rebalance your portfolio. For more information on these two issues, you should consult your financial advisor.

Going forward, we all must re-examine our actual risk tolerance. When times are good, it’s easy to tell yourself that you can weather the (hopefully) temporary storms of declining stock markets. This year certainly proves that living through a substantial bear market, in real time, is another matter entirely.

Finally, if you are so worried about the stock market that you are having trouble sleeping, consider scaling back your equity allocation. That way you will still maintain some exposure to stocks, rather than making an emotional decision to “sell everything.”

photo credit: lexdennphotography

Is It Different This Time? Part 5

“One of the fallacies about the recent financial turbulence is that the markets are in ‘uncharted territory’ and that there are no historical precedents for the volatility, panic, or economic uncertainty that we’ve observed. To make statements like this is to admit that one has not examined historical evidence prior to the 1990′s. The fact is that we’ve observed similar panics throughout market history. – John P. Hussman.

I tend to read market commentaries with a jaundiced eye. That’s because the authors generally restate the obvious, i.e. what has already happened, or they attempt to predict the future, which is simply impossible.

The Stock Market is Not in “Uncharted Territory,” the November 17th Market Commentary by John P. Hussman is an exception. Rather than make definitive predictions, he outlines his strategy by putting the stock market and the economy in historical perspective. Here are some quotes I like:

Investors can get a good understanding of market history by examining a great deal of data, or by living through a lot of market cycles and learning something along the way. Only investors who have done neither believe that current conditions are “uncharted territory.” Veterans like Warren Buffett and Jeremy Grantham have a good handle on both historical data, and on the concept that stocks are a claim to a very long-term stream of future cash flows. They recognize that even wiping out a year or two of earnings does no major damage to the intrinsic value of companies with good balance sheets and strong competitive positions.

Most importantly, these guys never changed their standards of value even when other investors were bubbling and gurgling about a new era of productivity where knowledge-based companies would make the business cycle obsolete, and where profit margins would never mean-revert. They knew to ignore the reckless optimism then, because they understood that stocks were claims on a very long-term stream of cash flows. They know to ignore the paralyzing fear now, because they still understand that stocks are a claim on a very long-term stream of cash flows.

No thoughtful investor “calls a bottom” in the markets. Stocks are undervalued here, but they could decline further. Economic conditions are poor, but may be over or under-reflected in stock prices. Investors will find out over time, and the ebb-and-flow of information is slow enough to allow very large market fluctuations in the meantime.

Recent market conditions seem like they have no precedent only because so many investment professionals know only the data they’ve lived through. If one actually examines market data from the Great Depression, 1907, and other less extreme panics, one realizes how much the recent decline has already discounted potential economic negatives. At this point, further declines in stock prices simply increase the long-term returns that investors can expect over time. We can’t rule out the possibility that investors could get more frightened, or that they might abandon their stocks at prices that would offer extremely high long-term returns to the buyers. It is important to establish exposure slowly, but long-term investors who ignore attractive valuations are not investors at all.

The main damage that investors can do to their financial security at this point would come from selling into steep but impermanent declines.

As a side note, do your best to filter out comments like “investors are moving out of stocks and into …” or “investors are selling into this decline” or “investors are buying into this rally.” On balance, investors do not sell shares, and they don’t buy shares. Every share purchased is a share sold. The only question is what price movement is required to prompt a buyer and a seller to trade with each other. No money will come off the sidelines into stocks. No money will come out of stocks and onto the sidelines. All such talk is non-equilibrium idiocy. Keep in mind that the “market” consists of different traders with a variety of time-horizons, risk-tolerances, and analytical methods (e.g. technical, report-driven, value-conscious). It is helpful to think in terms of which group of individuals is likely to do what, and when. It is equally important to know which group of investors you belong to. As the old saying goes, if you’re at a poker table and you don’t know who the patsy is, you’re the patsy.

Conclusion

No one knows or can accurately predict where stock prices are heading in the short term. It is true that if we have another Great Depression, stock prices will decline further. It is also true that after the steep decline (which we have already experienced, and which is not unprecedented) future returns are likely to be higher, not lower.

In the long term, investors are compensated for taking risks. Consequently, it is highly unlikely that, over the long term, safe investments will have higher returns than equities.

Timing the “market bottom” is impossible, but selling stocks now will most likely result in regrets later.

photo credit: erin MC hammer

The Financial Crisis: Why Were The Experts Wrong?

“Speculative bubbles are caused by contagious excitement about investment prospects. I find that in casual conversation, many of my mainstream economist friends tell me that they are aware of such excitement, too. But very few will talk about it professionally.” – Robert Shiller.

Robert Shiller is a Professor of Economics and Finance at Yale University and the author of “Irrational Exuberance,” a book that was first published in 2000. In his book, Shiller warned that the stock market had become a bubble and could have a sharp decline, which, of course, it did. In the 2005 update of that bestseller, he stated clearly, “that a catastrophic collapse of the housing and stock markets could be on its way.”

If someone is right once, you could chalk it up to pure luck. But when you’re spot on twice – well, that looks a lot like skill to me.

In today’s edition of The New York Times, in a column entitled Challenging the Crowd in Whispers, Not Shouts, Shiller writes how he felt about going against the consensus, and how many economists might “pull their punches” to avoid being ostracized or at least, losing credibility. This column helps to answer the question Gary Becker and Richard Posner asked: The Financial Crisis: Why Were Warnings Ignored?

Alan Greenspan, the former Federal Reserve chairman, acknowledged in a Congressional hearing last month that he had made an “error” in assuming that the markets would properly regulate themselves, and added that he had no idea a financial disaster was in the making. What’s more, he said the Fed’s own computer models and economic experts simply “did not forecast” the current financial crisis.

Mr. Greenspan’s comments may have left the impression that no one in the world could have predicted the crisis. Yet it is clear that well before home prices started falling in 2006, lots of people were worried about the housing boom and its potential for creating economic disaster. It’s just that the Fed did not take them very seriously.

According to Shiller, the bubble was obvious even to the casual observer.

For example, I clearly remember a taxi driver in Miami explaining to me years ago that the housing bubble there was getting crazy. With all the construction under way, which he pointed out as we drove along, he said that there would surely be a glut in the market and, eventually, a disaster.

But why weren’t the experts at the Fed saying such things? And why didn’t a consensus of economists at universities and other institutions warn that a crisis was on the way?

For the answer, Shiller turns to social psychology and behavioral economics. Briefly, even experts fear ostracism, and many economists use only a limited set of tools regarding speculative bubbles.

The field of social psychology provides a possible answer. In his classic 1972 book, “Groupthink,” Irving L. Janis, the Yale psychologist, explained how panels of experts could make colossal mistakes. People on these panels, he said, are forever worrying about their personal relevance and effectiveness, and feel that if they deviate too far from the consensus, they will not be given a serious role. They self-censor personal doubts about the emerging group consensus if they cannot express these doubts in a formal way that conforms with apparent assumptions held by the group.

Members of the Fed staff were issuing some warnings. But Mr. Greenspan was right: the warnings were not predictions. They tended to be technical in nature, did not offer a scenario of crashing home prices and economic confidence, and tended to come late in the housing boom.

From my own experience on expert panels, I know firsthand the pressures that people — might I say mavericks? — may feel when questioning the group consensus.

I was connected with the Federal Reserve System as a member the economic advisory panel of the Federal Reserve Bank of New York from 1990 until 2004… In my position on the panel, I felt the need to use restraint. While I warned about the bubbles I believed were developing in the stock and housing markets, I did so very gently, and felt vulnerable expressing such quirky views. Deviating too far from consensus leaves one feeling potentially ostracized from the group, with the risk that one may be terminated.

In 2005, in the second edition of my book “Irrational Exuberance,” I stated clearly that a catastrophic collapse of the housing and stock markets could be on its way. I wrote that “significant further rises in these markets could lead, eventually, to even more significant declines,” and that this might “result in a substantial increase in the rate of personal bankruptcies, which could lead to a secondary string of bankruptcies of financial institutions as well,” and said that this could result in “another, possibly worldwide, recession.

I distinctly remember that, while writing this, I feared criticism for gratuitous alarmism. And indeed, such criticism came.

I gave talks in 2005 at both the Office of the Comptroller of the Currency and at the Federal Deposit Insurance Corporation, in which I argued that we were in the middle of a dangerous housing bubble. I urged these mortgage regulators to impose suitability requirements on mortgage lenders, to assure that the loans were appropriate for the people taking them.

The reaction to this suggestion was roughly this: yes, some staff members had expressed such concerns, and yes, officials knew about the possibility that there was a bubble, but they weren’t taking any of us seriously.

I based my predictions largely on the recently developed field of behavioral economics, which posits that psychology matters for economic events. Behavioral economists are still regarded as a fringe group by many mainstream economists. Support from fellow behavioral economists was important in my daring to talk about speculative bubbles.

Speculative bubbles are caused by contagious excitement about investment prospects. I find that in casual conversation, many of my mainstream economist friends tell me that they are aware of such excitement, too. But very few will talk about it professionally.

Why do professional economists always seem to find that concerns with bubbles are overblown or unsubstantiated? I have wondered about this for years, and still do not quite have an answer. It must have something to do with the tool kit given to economists (as opposed to psychologists) and perhaps even with the self-selection of those attracted to the technical, mathematical field of economics. Economists aren’t generally trained in psychology, and so want to divert the subject of discussion to things they understand well. They pride themselves on being rational. The notion that people are making huge errors in judgment is not appealing.

In addition, it seems that concerns about professional stature may blind us to the possibility that we are witnessing a market bubble. We all want to associate ourselves with dignified people and dignified ideas. Speculative bubbles, and those who study them, have been deemed undignified.

In short, Mr. Janis’s insights seem right on the mark. People compete for stature, and the ideas often just tag along.

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.

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