In search of the perfect stock market forecast
A Wall Street veteran who has made lots of predictions, good and bad, explains what can go right, or horribly wrong, with market forecasts.
Hundreds of “experts” have forecast the result of this Sunday’s Super Bowl. Millions more are betting on it.
And at this minute, not one of them has the slightest idea as to whether or not they are right.
Is it any different with the stock market? Stock market forecasts would be a lot more helpful if they were all in accord.
But sit down twelve experts, and you’re liable to get five bulls, four bears and two who are “bearish for the near term but bullish for the long term” and another who has it the other way around.
Never mind what’s going to happen next week. How do we know that toxic debt won’t surface in yet another European country and send the markets into a tailspin?
That doesn’t mean all market predictions are useless. They can tell us a great deal about what to expect. They can give us a framework within which to make investment decisions.
They just can’t tell us exactly what’s going to happen and precisely when it’s going to happen.
For an illuminating look at the art of forecasting, we turn to a Wall Street veteran who has made his share of good and bad forecasts.
Mr. Raymond DeVoe, Jr. made his worst forecast back in 1975. In the latest issue of The DeVoe Report he discusses the perils of predicting. And unreformed, he concludes with one more prediction.
Never let them forget
The late Mr. Pierre Rinfret was both an economist and a comedian (we could make a crack about some economists being unintended comedians, but we won’t).
He had a set of rules for making forecasts, which Mr. DeVoe quotes in full.
1. If you are going to forecast, forecast frequently. You can later pick the one that was closest to being correct.
2. If you give a number, don’t give a date.
3. If you give a date, don’t give a number.
4. If by some colossal combination of circumstances, compensating errors and luck you turn out to be right — NEVER LET THEM FORGET IT!
The author follows these rules with his own admission that he has made many forecasts he was not proud of, including the worst ever — Mayday 1975.
It only hurts when he laughs
For years, Wall Street worked on fixed price commissions. Then the Securities and Exchange Commission mandated that as of May 1, 1975, commissions would be negotiable.
Won’t matter, said Mr. DeVoe at the time, predicting it “would be the biggest non-event in Wall Street history.” Institutions would always pay a premium for quality research, he reckoned.
What he had failed to see was that the new rules were about to spawn the discount brokerage. The downward spiral that would see commissions drop from 45 cents a share to 5 or 6 cents was under way.
Within four years later, Mr. DeVoe had been through four mergers and lost 100 per cent of the capital he had built up in the previous decade.
He framed a cartoon that illustrated his feelings at the time. A guy in the jungle is pinned to a tree with a spear through his chest. “It only hurts when I laugh,” reads the caption.
“Almost 35 years later, I can still feel the twinges when I think of it,” admits the author.
The Forecaster’s Trap
Mr. DeVoe enjoys movie references. He uses the climactic scene in The Bridge on the River Kwai to highlight a more recent forecast. As bodies and train parts litter the river, the British army doctor repeats the word “madness” several times over as the screen goes black.
And “Madness” was the word that headlined his August 12, 2008 report. At that time, the Dow Jones Industrial Average was soaring above 10,000 — and the credit markets were deteriorating rapidly.
This time, Mr. DeVoe was right. He had turned bearish on the market well before that date. “As Wall Street veterans and housing speculators also know, manias can go on longer than rational people think they can — there is virtually no limit on how irrational price levels can become.”
Eight years earlier, he had used the very same heading when the NASDAQ Composite hit 5048 with dot-com start-ups flooding the market.
In these and numerous other cases, many fell into “The Forecaster’s Trap” — the belief that a trend in motion will stay in motion, with minor variations for outside influences and unexpected developments.
But trends do change, and often veer off in a completely different direction. Mr. DeVoe returns ruefully to his Mayday call on commission rates. “I and many others did not understand the possibility of a game changer” — an event that sparks a “revolutionary upheaval.”
In fact, he says in conclusion, we may once again be faced with a “game changer.”
Look at the multiple causes of this recession. An almost 15 year credit bubble, the collapse of the housing bubble, a near breakdown of the financial system, massive government spending and deficits and a dangerous bond bubble.
These are all departures from previous experience, he says. That means “this recession is different from others. Similarly, the recovery will be quite different.” This mess will take a long time to resolve.
If we knew that the New Orleans quarterback was going to throw four interceptions on Sunday or that the price of oil was going to rise dramatically on the first day of March, we could undoubtedly make a lot of money in a hurry.
But we don’t. So the wisest forecast is still this. Expect the unexpected and invest accordingly.
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