Apr 21, 2013

Financial Prediction Fallacies

One of the more interesting myths in the investment world is that large financial institutions, with their access to mountains of data poured over by teams of staff economists, can determine where the markets are going and profit accordingly. Gullible investors believe this even though, every year, we can go back to the confident predictions of brokerage firm leaders and leading hedge fund managers and see a hard-to-explain gulf between expectation and reality.

In 2012, the broad U.S. markets delivered roughly a 16% return, depending on which of the indices you’re measuring. So let’s jump into a time machine and see whether the brokerage firms were telling us to go all-in on stocks and take full advantage of this nice little bull market run.

They weren’t. Adam Parker, who serves as the U.S. equity strategist for the mighty Morgan Stanley organization, boldly predicted that the S&P 500 index would fall 7.2% in 2012. He recently said that he underestimated the impact of central bank stimulus. Credit Suisse “strategist” Andrew Garthwaite, Wells Fargo “strategist” Gina Martin Adams, and Bank of America/Merrill Lynch “strategist” Savita Subramanian forecasted essentially flat returns for U.S. equities.

David Kostin of Goldman Sachs, meanwhile, predicted that the S&P 500 would drop 25% in the midst of a euro collapse, and boldly predicted that Europe’s sovereign debt crisis would worsen “almost daily.” John Paulson, founder of what may be the most famous global hedge fund based in New York, told clients in April that he was wagering heavily against European sovereign bonds. UBS economist Jonathan Golub forecasted struggling equities in the face of European recession.

In fact, the Eurozone became practically the epicenter of bad Wall Street predictions; crafty traders watched in dismay as Greek bonds surged 80% in value in 2012, and the euro itself strengthened about 9.4% from its July 24th low against the dollar. Germany’s DAX index of stocks managed to survive the predicted free fall by returning 29% to investors who ignored their brokers and stayed the course in Europe. The most dire predictions came from Citigroup economist Willem Buiter in London, who told reporters last February that there was a 50% chance Greece would leave the euro within 18 months. In May, he raised the risk to 75%, and cited a 90% chance of departure in July.

2012 is not an isolated incident; in fact, last year a company called CXO Advisory Group ― which tracks more than 60 market “gurus” calculated that the average Wall Street expert forecaster had been accurate only 48% of the time over the long-term. Translated, that means that a coin flip is a slightly more accurate predictor of the future than the experts you see on cable’s financial TV channels.

But of course this is the season when, once again, the experts and economists get out their crystal balls to tell you where the markets are going in 2013. You are about to be deluged with confident predictions from Wall Street, along with Money Magazine telling you “the smart place to put your money now.” Our best advice is to turn off the TV, close the magazines, and pull out a more reliable guide to the future: any one of the coins in your pocket with a “heads or tails.” Sticking to your long-term investment plan is far more important and impactful than any prediction.