Larry Swedroe

Never In Doubt, Often Wrong

Economists, if they are smart, learn to never make forecasts, especially about the future. If they have to make a forecast, they learn to never give a number. And, if they have to give a number, they learn to never give a date. In that way they can never be proven wrong. They learn this from being students of history and from personal experience. Forecasting is an extremely difficult thing to get right, especially (as Yogi Berra would say) if you are forecasting the future. The track record of economists is dismal (perhaps that is the real reason it is called the dismal science). The track record of market strategists is equally dismal. Despite this, the press and media focus on forecasts (though rarely holding the forecasters accountable, for accountability would end the game) and investors pay great attention to them; allowing the forecasts to influence or even determine their investment strategy.

The year 2001 provided further evidence that the winning strategy for investors is to treat the forecasts of market strategists as entertainment, a more politically correct description than Jane Bryant Quinn's "investment pornography." At year-end 2000, the Wall Street Journal polled the market strategists of nine leading investment houses. With the S&P 500 Index closing the year at 1320, the forecasts ranged from a high of 1715 (Ed Kerschner of UBS Warburg) to a low of 1320 (Richard Bernstein of Merrill Lynch). One forecaster, Steve Galbraith of Morgan Stanley provided a range of 1375-1225. Since the Index closed the year at 1148 (down 13%) not one of the eight forecasters that provided a single point estimate even got the direction correct. Certainly, getting the direction correct is the most important part of the forecast. Kerschner's forecast of a thirty percent gain proved to be almost fifty percent above the year-end close. And, the press's darling of the late 1990s, Abby Joseph Cohen of Goldman Sachs, had a forecast that proved to be only forty-three percent too high.1

Another example of the folly of allowing either market strategists or active fund managers to influence investment policy is the BusinessWeek stock-picking contest. They chose four top mutual fund managers to build a portfolio. The contest ran for the period December 8, 2000 through December 14, 2001. The best of the four, the Royce Opportunity Fund (a small value fund) gained 14.2%. By comparison, the passively managed DFA Small Value Fund rose 22.7% (calendar year 2001). Though the dates are somewhat different, the Royce Fund underperformed an appropriate benchmark by about 7%. The other contestants lost 25.5%, 27.2%, and 39.7%, respectively.2 So much for either the skills of active managers or BusinessWeek's ability to identify ahead of time fund managers that will outperform.

The winning strategy is to ignore the forecasts of market strategists and avoid actively managed funds. They are both part of the strategy known as the losers game-it's not that you cannot win, its just that the odds of doing so are so poor that it doesn't pay to play. The winning strategy is to build a globally diversified portfolio of passively managed funds that reflects your ability, willingness and need to take risk, and then having the discipline to stay the course. Unless something in your life has changed that would impact your ability, willingness, or need to take risk, the only actions that should be taken are rebalancing and tax loss harvesting. One other piece of advice: If you must watch CNBC, and cannot resist treating it as just entertainment, make sure to hit the mute button.

1. Wall Street Journal, December 10, 2001.
2. BusinessWeek, December 31, 2001.

Larry Swedroe is the author of What Wall Street Doesn't Want You to Know and The Only Guide To A Winning Investment Strategy You'll Ever Need. His third book, Rational Investing In Irrational Times: How to Avoid the Costly Mistakes Even Smart People Make Today, will be published in April 2002 by St. Martins Press. Larry is also the Director of Research for and a Principal of both Buckingham Asset Management, Inc. and BAM Advisor Services in St. Louis, Missouri. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management or BAM Advisor Services.