What do fortunetellers, psychics, and stock market forecasters have in common? They all claim to know what happens next…for a price.
But how good are they? Horrible! Yet some investors pay for it anyways. It’s a lesson investors can learn from history.
Alfred Cowles was one of the first to put market forecasters to the test almost a century ago. He conducted two studies, the first in 1932 and again in 1944.
The first study was based on the period from 1928 to 1932. Cowles first looked at how successful 20 insurance companies and 16 financial services were at picking stocks that would outperform the market. He next looked at the accuracy of 25 financial publications in predicting the movements of the markets. He also included the 26-year record of the editor of the Wall Street Journal, Peter William Hamilton.
The results were not surprising.
- Sixteen financial services, in making some 7,500 recommendations of individual common stocks for investment during the period from January 1, 1928, to July 1, 1932, compiled an average record that was worse than that of the average common stock by 1.43 percent annually. Statistical tests of the best individual records failed to demonstrate that they exhibited skill, and indicated that they more probably were results of chance.
- Twenty fire insurance companies in making a similar selection of securities during the years 1928 to 1931, inclusive, achieved an average record 1.20 percent annually worse than that of the general run of stocks. The best of these records, since it is not very much more impressive than the record of the most successful of the sixteen financial services, fails to exhibit definitely the existence of any skill in investment.
- Twenty-four financial publications engaged in forecasting the stock market during the 42 years from January 1, 1928, to June 1, 1932, failed as a group by 4 percent per annum to achieve a result as good as the average of all purely random performances. A review of the various statistical tests, applied to the records for this period, of these 24 forecasters, indicates that the most successful records are little, if any, better than what might be expected to result from pure chance. There is some evidence, on the other hand, to indicate that the least successful records are worse than what could reasonably be attributed to chance.
The collective predictive abilities not only failed to beat the market but any success was nothing more than random luck. A coin flipper could have done as good of a job as the average forecaster of the time.
As for Mr. Hamilton’s 26-year track record — it was no better than a coin flip either. He made 90 pronouncements over the 26 years related to changes in the market. He predicted 45 correctly and 45 incorrectly.
In fact, an investor religiously following Hamilton’s edicts would have been better off owning a basket of the stocks in the Dow Jones index. From 1904 to 1929, Hamilton’s predictions would have earned a 12% annual return. Not bad…until you compare it to the 15.5% annual return of the Dow Jones.
To be fair, four years is a small sample size. So Cowles revisited his study 12 years later. The biggest difference was the number of financial publications no longer in service. Of the original 24, over half had shut down.
Of the 11 publications remaining, 4 had records covering 10 to 11 years and 7 had 15 years of predictions. The results, however, were the same.
The records of 11 leading financial periodicals and services since 1927, over periods varying from 10 to 15½ years, fail to disclose evidence of ability to predict successfully the future course of the stock market.
In fact, Cowles found that many of the forecasts were so unclear that in some cases, an argument could be made that a reader’s interpretation of the prediction was wrong. In other words, the forecasts were perfect for someone wanting to claim they correctly predicted something even though it was not actionable advice. Investors were left guessing about what the forecaster meant.
Yet, people still paid for the services. And the reason should come as no surprise.
As J. Scott Armstrong once wrote, “No matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers.” People have always looked for shortcuts to getting rich quickly. Market forecasters sell the hope of doing so. Plus it gets investors off the hook for making their own decisions.
A confident prediction, tied to a recent track record of success — 1 time in a row will do — is enough to convince people to listen. It’s noise. The best thing you can do is tune out market forecasters entirely.
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