QUESTION: What do you call an “expert” that claims to know where the market is headed?
ANSWER: A liar.
Don’t trust anyone that claims to know what’s going to happen in the future. The world is too complex. The stock market, the weather, the mood of your spouse…there’s no telling.
Recall back to September 10, 2001. Do you remember anyone predicting a terrorist attack the following day? That’s an extreme example, but on 9/11 it only took nineteen hijackers to change modern history. Now consider how one small insignificant event could cause your stock portfolio to drop 10%. During any given minute, there are 7 billion people on earth whose actions could impact the market. Factor in natural occurrences and it’s evident that long term predictions are futile. It doesn’t matter how “super” the super computers get or how sophisticated the algorithm, the world is too complex. Too chaotic.
The proper course of action is to make near term forecasts that are protected against catastrophic loss. To paraphrase Ronald Reagan’s “trust but verify”, as investors we want to “forecast and hedge”. (See prior article on the use of Protective Puts.)
As to near term forecasting, on an elementary level it’s comparable to observing the weather. In San Diego if it were sunny and warm yesterday, and it’s sunny and warm today, there is a high probability it will be sunny and warm tomorrow. If a stock had increasing earnings last quarter, and increasing earnings this quarter, there is a strong probability that it will have increased earnings next quarter. Simplistic? Yes, but that’s the essence of securities analysis.
Near term forecasting consists of two basic elements. Fundamental and Technical analysis. Fundamental refers to the stock’s underlying value- for example, a strong balance sheet and multiple quarters of increased earnings. Technical refers to the stock’s price and volume action.
Combining the two elements, an investor can make near term forecasts on the direction of a stock.
As an example of near term forecasting accuracy, consider Investor’s Business Daily (IBD) market outlook. Chart 1 is derived from IBD market outlook commentary superimposed on the SPY S&P500 index exchange traded fund. Over the 21 month period IBD was directionally accurate in their outlook. This type of forecasting is especially effective for a disciplined investor. One that is patient and waits for the market to prove itself, thus avoiding market turbulence.