Why You Should Never Trust Market Predictions

There was a psychic with the strange name of Baba Vanga that predicted the 9/11 terrorist attacks. Even though the prediction she made was quite ambiguous, she received a lot of media attention.

A Zimbabwean preacher, Uebert Angel, correctly predicted the death of ex South African President Nelson Mandela. He got quite a bit of media attention.

Paul the Octopus (yes, this was really a common octopus and not a person) correctly predicted the results of eleven 2010 Soccer World Cup games. Are you were wondering how the octopus did that? Well, writing it on an aquarium wall would certainly be a feat! But that is not what happened. Paul’s owners would present him with two boxes containing food. Each box was identical except for the fact that, on each box, there was a country flag of the competitors of an upcoming football match. Whichever box Paul ate from first would be considered his prediction for the winning team. Correct predictions brought him worldwide attention as an animal oracle.

John Poulson, now famous fund manager, correctly predicted the housing crash of 2007-2009. He made a lot of money and there was even a book, The Greatest Trade Ever, written about him.

Now here it starts to get interesting…

Market predictions are a dime a dozen

Baba Vanga is just one out of thousands of psychics who make predictions every year. 99% of them are wrong, but nobody writes about them. The headline that says, “Psychic X missed his last three predictions about the future,” doesn’t sell newspapers.

There are thousands of preachers and prophets who predict different events every year. The most popular ones are, of course, the ones about the end of the world. Now, as you are still alive reading this book, I assume that none of these predictions were correct.

After Paul the Octopus, there were thousands of other animals, including elephants, cats and even worms whose owners tried to predict the outcome of different sports tournaments and games. I guess you can figure how that turned out.

There are thousands of investing gurus writing articles, books and making predictions on TV about what will happen next with the stock market or the price of oil. How come the media forgets about them when they are proved wrong?

Even John Poulson’s performance after his winning trades of 2007 is far below average. Let me just give you a short excerpt from a Bloomberg Business article about him from 2015[i]:

“Billionaire John Paulson posted the second-worst trading year of his career in 2014 as a wrong-way energy bet added to declines tied to a failed merger and investments in Fannie Mae and Freddie Mac.

The worst performance was in the Advantage Plus fund, which plummeted 36 percent last year, two people with knowledge of the returns said…

The manager, who shot to fame after making $15 billion on the housing crisis in 2007, has struggled to regain its footing since 2011 when bets on the U.S. recovery went awry, losing money in all of its main strategies – including a 51 percent tumble in the Advantage Plus fund. Paulson also lost money in investments tied to gold and Europe’s economy, causing assets to dwindle to $19 billion, half the peak in 2011.”

See the pattern here?

Predictive power or just luck?

There are thousands of fund managers and gurus out there. Some of them get lucky in a certain period of time. They become famous. They start attracting a lot of new investors with fresh money. Then they run out of luck and start producing below average or even negative returns. So, all the people who started to invest with them, or who invested based on their recommendations, get burned. This has happened thousands of times in recent history and will happen again and again.

You only get to know which predictions will be correct afterwards. When it’s too late.

Let me illustrate this point with a simple thought experiment. Let’s say that you have a thousand computers. They are all programmed to make one exact prediction about the next price-move of a randomly selected stock. For example, the stock is now at $7 and the first computer predicts that in one year it will be at $9, the second one forecasts it will be at $6.5 and so on.

Do you think that some predictions will come true? Sure they will! There is a mathematical probability that a small number of computers will hit the mark.

But will you jump around with your hands in the air claiming that the computers that hit the mark have predicting powers? And would you bet your retirement fund that their next prediction will be on target? Probably not.

So, whether you are Paul the Octopus, or John Paulson, you can just admit it: you were just lucky once or twice. I couldn’t emphasize this more: the fact that somebody correctly predicted the last crisis, or the last big gold price-move, doesn’t mean that he/she has reliable predicting abilities. He or she was just lucky.

Monkeys vs. stock picking experts

Are there some exceptions? No. We have yet to find an investing guru who correctly predicted more than one or two big price movements or important events.

CXO Advisory Group has been collecting data from 68 market forecasters from 1998 to 2012. In that period of time, they collected more than 6,500 predictions made by these famous investing gurus and experts. Some of them predicted that a certain stock would go up or down and some predicted the course that the market, as a whole, would take. Then in a very comprehensive study, they analyzed if the predictions these forecasters made were right or wrong[ii].

Now, if you were making 6,500 up or down predictions, you would probably end up being correct half of the time. This is the standard mathematical probability. 50% of your predictions would be proven right and 50% wrong.

But guess how the gurus fared…

There were some of the well-known names analyzed in that study. For example, Ben Zacks, the co-founder of the well-known Zacks Investment Research, and portfolio manager at Zacks Wealth Management Group, had a score of exactly 50%.

James Dines, founder of The Dines Letter newsletter, a guy who is often referred as “one of the most accurate and highly regarded security investment analysts today”, was also correct only half of the time. That’s really very accurate.

And, my favorite – Robert Prechter, known for his financial forecasts using the Elliott Wave Principle and author of multiple investing books. His score was… wait for it… 20.8%. Now, you really need a lot of bad luck for that.

Can you beat famous investing gurus by tossing a coin?

And the average score across all of their predictions?

Most forecasters were right in the 40% to 60% range, with some deviations to the upper and lower side. So, the best score out of all forecasters was 68.8% and the lowest was 20.8%. That’s exactly what you would expect from a random distribution – a typical bell curve.

And the average across all predictions was 46.9%. In less than half of their predictions, they were right. If you would employ monkeys to throw darts (unfortunately octopus doesn’t throw darts), they would, on average, fare better than that.

In other words – you can beat these famous investing gurus by just tossing a coin. Assuming that the coin toss is fair, heads and tails are equally likely. And 50% always beats 48%. It’s that simple. So, next time you see a famous guru making predictions, simply ignore him or her. He/she just wants to get some media attention and sell some more books or events.

Let me predict something…

Hmmm… You know what? That might not be a bad idea. If it worked for others, it might work for me, too…

So let’s do it!

Drumroll please…

I will predict the price of… let’s say oil… for the next 5 years.

Now, this is very demanding challenge. Let me look into my mystic crystal ball that I always keep in my closet. Yes, yes! I see it! I can see more than one path that the future can carve. Make sure to take some notes…

The first scenario that I can see is the price going up. Yes, that’s it! There you have the first scenario.

Now, the second scenario. This one is a little fuzzy. But yes, now it’s getting clearer! In the second scenario, the price will go down! Oh my god! Did you expect that? I certainly didn’t. What a surprise!

And now there is a third scenario. This one is less likely, but still I can see it in the future. So the third scenario is that the price will stay the same.

But wait!!!

Something else is going on in my crystal ball now. I can also see another scenario! There is a big spaceship. And it’s firing a huge laser beam directly towards Earth. Looks like the aliens want to make their new hyperspace bypass, and Earth is in their way.

In that case, we won’t care what the price of oil will be.

Let me end this article with a warning. Even after all the proof that the predicting abilities of gurus and other domestic or wild animals are zero, I still get a lot of emails asking me what will happen to the price of stocks, gold, some cryptocurrencies and other assets in the next year:

“Robert, I read your book and I really liked the segment about the predicting abilities of investing gurus. I know that gurus cannot predict what will happen, but still…can you tell me what you think will happen to the price of _____ (insert your favorite asset here) in the next year?”

Some people just don’t get it. The only two things that are certain in this world are death and taxes!

[i] “Paulson Event-Driven Fund Said to End Last Year Down 36%”, Bloomberg.com, January 11, 2015. https://www.bloomberg.com/news/articles/2015-01-11/paulson-event-driven-fund-said-to-end-last-year-down-36-
[ii] You can get the complete methodology and results of the study at http://www.cxoadvisory.com/gurus/