Predicting the Markets and Market Forecasts

January brings out all the experts as they attempt to predict what the stock market and the economy will do in 2011. As the year progresses most of them turn out to be wrong. I read an interesting article on market forecasts in the WSJ recently. It does a good job verbalizing what I think most of us already inherently know (Here for Full Article).

Although most of the forecasts turn out incorrect, we still should review / examine them to learn. Taken together, forecasts can point to a “high / low” you can reasonably expect for a given year. Forecasting has been around since there were markets to invest in – all the way back to ancient Mesopotamia.

Let’s look at some of last year’s predictions if you recall – stocks would collapse, due to a “double-dip” recession. As we know now, that’s not what happened at all – the markets had a very nice year and it seems the economy keeps muddling through to a recovery.

How about 2011 – forecasters say stocks will go up 10%, 10 yr Treasury yields will run 3%, inflation under 2%, and the economy expands 3%. So as we already know, it would be naïve to think one could position a portfolio strictly on the forecasters.

Why do people with years of experience, massive expertise and mountains of data at their disposal so often get the future wrong?

It’s an art and a science.

The future is full of surprises; no one, no matter how expert, can reliably anticipate what will happen and more importantly, how people will react to it. The market is complex, with many individuals / groups that will react unpredictably to any given event – given their own circumstances at that moment time (next time, they might act differently).

Pundits also go wrong because they tend to be either too conservative or too extreme. To make a name for themselves, they must forecast an “extreme”. If they turn out to be right, their accuracy will seem miraculous and they will be famous; if they turn out to be wrong, most people will forget.

Familiar names – 1987 Crash – Elaine Garzarelli; 2008 Recession – Noriel Roubini; 2007-’08 Banking Crisis – Meredith Whitney.  However, very few, if any, pundits have made more than one great call in a career.

Make use of Forecasts

Since each forecast may use variable inputs, one technique I’ve used for years is “averaging” several forecasts. Why is it effective? You cast a “wide net” over a large amount of information, so the errors will frequently offset one another. In the article they reference a Duke Professor who’s done research on the subject.

Another alternative is to use the forecasts to set “ranges” of possible outcomes.  The consensus for the 10 yr Treasury is 3.25% by the end of 2011. Based on historical error, there is roughly an 80% chance the yield will finish between 2% – 4.5%; in other words, bonds could be up as much as 9% or down in the 10% range.

By seeing how wide the potential rang of error is, one can adjust your own expectations to make sure you don’t make too large a bet in either direction.

In the end, of course, no approach can make all forecasts hit the target. If you are a long-term investor, you should accept that short-term markets moves aren’t predictable, and there is little point in making large directional bets. In most cases, long-term average returns, while far from perfect, are one of the best forecasters we have.

One more point, while you can’t “predict” the future, you can “plan” for it. During the Great Recession of the last couple years, research shows investor who had written financial plans were 50% more likely to feel “wealthier” coming out of it, than those without a written plan. 

Additionally, those with a financial plan are significantly more likely to be optimistic about their financial future, have already achieved a large number of their financial goals, are more comfortable financially, and view their wealth as secure for the long term. At a minimum, a financial plan seems to provide investors with more peace of mind and a more positive outlook. 

Are you on track? We’ve got a great tool to use as a starting point – Click HERE for your Free Financial Road Map!