The pitfalls of stock market predictions
The bolder a market prediction is, the more wary you should be, says this U.S. advisory, which has also made a Canadian telecom a top buy.
Bold advice sure gets attention.
But it may not be the right advice. It may be more impressive for audacity than accuracy.
In fact, even a bold negative prediction could turn out to be nonsense.
This is how one of America's top investment advisories puts it.
"For the investment adviser seeking publicity, the value of a bold and unequivocal prediction is tough to overstate,” says Dow Theory Forecasts.
"A newsletter editor promising a surefire winner set to double will get attention, as will one predicting a drop in the Dow Jones Industrials below 1,000."
The writer is the advisory's editor and director of research, Mr. Richard Moroney, CFA.
Sound advice can be rather boring, he says. But it does have one thing going for it. Although it may be less exciting and more sleep-inducing than the spectacular forecast, it also tends to let you sleep better at night.
Before we enter the land of crystal balls, we’ll pause briefly for a forecast of good things for a Canadian stock.
The highest score
Among its top choices for gains over the next 12 months — or Focus Buys — this prominent U.S. advisory lists just eleven large cap stocks.
One of them is Canadian. The choice is cable giant Rogers Communications Inc. (TSX-RCI.B: NYSE-RCI), which holds a unique place on this advisory’s scorecard.
Dow Theory Forecasts has a precise stock rating system based on momentum, quality, value, financial strength, earnings and volume.
Among the large cap stocks on its buy list, Rogers comes in first at an overall percentile rank of 99, with 100 as the highest possible score.
Rogers, which has just won the naming rights to the Vancouver Canucks arena and is launching a new mobile phone brand, has been doing reasonably well in a schizophrenic market.
At $35.78 it is close to the 52-week high it achieved a month ago, and it is yielding a healthy 3.6 per cent on its $1.28 dividend.
Tough way to make a buck
Recommending a diversified portfolio “with some cash as a hedge against market weakness may not attract much notice,” says Mr. Moroney. After all, you don’t need either of these things if you know how the future is going to unfold.
But that’s the problem. The editor quotes that bottomless fund of sayings, baseball legend Yogi Berra, who said: “It is tough to make predictions, especially about the future.”
If your investment approach is based entirely on making predictions and betting on the specific outcomes, you are embarking on what this editor describes as “a tough way to make a buck.”
There’s another, more subtle problem with predictions. Once the mind latches onto a prediction, it is difficult to let it go. Even contradictory evidence may not shift one’s belief in the certainty of the forecast.
A dart-throwing chimp
University of California psychologist Philip Tetlock carried out one of the best-known studies of the value of expert opinions. He solicited predictions from 284 professional economic and political forecasters.
Most of the questions had only three possible outcomes. Yet the experts picked the right answer less than one-third of the time. “A dart-throwing chimp would have beaten the vast majority of the professionals,” said one commentator about the study.
What’s more, the worst predictions came from the most famous experts, who were “consistently making overblown forecasts.” The likely explanation for this, says Mr. Moroney, is that their confidence in their own rightness caused them to disregard evidence that contradicted their own views.
To be fair, he adds that most of us tend to err on the side of over-confidence or exaggeration when respond to surveys.
And we all like a good story, with logical cause and effect explanations. We tend to overlook the effects that a bolt out of the blue, like the 9/11 terrorist attacks, may have on the course of events.
To guard against these all-too-human frailties, and “protect yourself from the dangers of certainty and expert opinion,” Mr. Moroney has three suggestions.
The most dangerous pundits
The first is the most obvious. Take expert predictions with “a big grain of salt.” Prognosticators are paid to predict, and so they do it whether or not they have any special insights to offer on a particular subject or not.
“Be particularly wary of pundits making bombastic, ironclad predictions,” says this editor. Those who seem the most confident may be the most dangerous.
Second, realize that we all love certainty and precise predictions. “It feels good to be certain.” Don’t rush to judgment. Force yourself to consider alternative conclusions and ideas that may contradict your ideas.
Finally, says Mr. Moroney, pay attention to the way you arrive at decisions. “As much as possible, make your decisions part of a process, a repeatable system you can amend based on your results. Learn from your mistakes.”
If you do, we predict you’ll be a better investor. And we stand by that prediction.
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