This blog was originally published in December, 2014
Do you have a favorite forecaster? If so, when is the last time you checked his or her track record? You probably should because research exists that shows professional forecasters are about as accurate, on average, as a coin flip.
The chart below is the result of an ongoing analysis of equity market experts and their forecasts — the so-called stock market gurus. Analysts collected data from market forecasters since 1998. They tracked and graded the forecasts, based upon accuracy, made by dozens of popular gurus over the years. And the results aren’t good! The “experts” accurately predicted market directions only 48% of the time — about as accurate as a coin flip.
CXO Advisory Group, Guro Grades
What is interesting is how quickly the accuracy rating fell below 50%. It took only 2 years and 200 predictions. Once the accuracy fell below 50 percent, it remained fairly stable for the rest of the period analyzed. It was so stable in fact, that the analysts didn’t see a need to continue the study. They felt the results were conclusive.
Why is it so hard to forecast the market? I believe it is because markets move in random and unpredictable ways.
The theory of random walks supports my belief.1 This theory starts with the assumption that markets are efficient. An efficient market is described as one with a large number of rational profit-maximizers actively competing and where information is freely available to all participants.
In an efficient market, competition among the many participants leads to a situation where actual prices of individual securities reflect the effects of all available information. The key is information. Most gurus have the same information, which probably explains why they tend to have similar forecasts or at least forecast the market to move in the same direction.
The dark side of this forecasting nonsense is the wealth destruction that results due to investors moving in and out of the market based on these predictions. So what do you do when the industry experts show less forecasting accuracy than a coin flip? Start flipping coins yourself? No, you stop trying to time markets. You have the courage that it takes to ignore economic forecasts from experts with very impressive credentials. Their logic is compelling and their rationale seems sound but don’t let that fool you into making an investment mistake with your clients’ wealth.
1 Fama, Eugene F., Random Walks in Stock-Market Prices, Chicago Booth Selected Papers Series, No. 16.