Ignore Market Experts

People want certainty. David Freedman, in his 2010 book “Wrong” offers the example of a person suffering from back pain. He visits two doctors to review his MRI. One doctor says that he has seen many similar cases and that it’s hard to say exactly what’s wrong. He suggests trying out a treatment and going from there. The other doctor says that he knows exactly what is wrong and knows what to do. Which doctor will he choose?

Most people will choose the doctor who seems certain about his diagnosis, but that doctor may very well be wrong. As much as we crave certainty, it rarely exists, and it definitely does not exist in the world of financial markets where returns are driven by events that cannot be consistently forecasted. Market experts want you to believe that their insights can help you make better investment decisions. Sell this, buy that.

It may be interesting to listen to market experts, but should you actually believe anything that they say?

In this episode of Common Sense Investing, I’m going to tell you why market experts are one of the worst sources of financial advice.

Let’s start off by remembering that there is a tremendous amount of evidence that actively managed funds, on average, consistently fail to outperform their benchmark index. Actively managed funds are groups of market experts working together to outsmart the market, and, on average, they are not able to make the right calls based on their own predictions. So why would some person claiming to be a market expert online, on the radio, or on TV be any different? Well, guess what? They are not any different.

There have been two comprehensive efforts to aggregate and analyze the predictions of stock market gurus.

One data set from CXO Advisory Group looked at the forecasts of 68 stock market experts spanning 2005 through 2012. They collected a total of 6,582 forecasts for the U.S. stock market. Some of the forecasts had been made as far back as 1998, ending by 2012. The forecasts were then compared to the S&P 500 over the future intervals relevant to the forecast. The analysis found that the aggregate accuracy of all forecasts was less than 50%.

The other study of predictions is called the Gurudex. It looks at the 12 month period ending in December 2015. Rather than focusing on individual market gurus, the Gurudex looks at the stock predictions of large institutions. Not only does the Gurudex assess the accuracy of the forecasts, but it also compares the return of an investor who had acted on all of the predictions to the return of the S&P 500 over the same time period.

For the twelve months ending December 2015, the Gurudex shows an average stock prediction accuracy of 43% for the 16 institutions that they tracked. It’s not like these are no-name institutions, either. RBC Capital Markets, BMO Capital Markets, Goldman Sachs, and UBS were all included. Only four of the 16 institutions had greater than 50% accuracy over the 12-month period. One of those four, a Japanese institution, batted 60%, while the other 3 were right 53% of the time, barely better than a coin flip. The accuracy numbers drop sharply from there.

If an investor had acted on each of the stock predictions that these large institutions made in 2015, they would have earned a -4.79% return while the S&P 500 was relatively flat at -0.69%.

In an attempt to explain such low accuracy for these supposed experts, the author of the CXO Advisory analysis points out an important perspective on forecasts. The market expert making a forecast may have motives other than accuracy. For example, some market gurus may be making extreme forecasts to attract attention to their institution or publication. This is an important thing to keep in mind when you read or listen to market experts – they don’t care about you. Their motivation might be driving traffic to their publication, or bringing attention to their product or service, but their focus is almost certainly not on giving you financial advice that is in your best interest.

One notable market expert, Andrew Roberts, the Royal Bank of Scotland’s research chief for European economics and rates, made headlines in early 2016 by advising investors to ‘sell everything’ in preparation for a ‘cataclysmic year’. This was sensational enough to be picked up and written about by the Telegraph, CNN, the Wall Street Journal, and the Financial Post, among many other publications. Of course 2016 went on to be an excellent year for investors. So did 2017. Woops.

Warren Buffett famously said “We have long felt that the only value of stock forecasters is to make fortune-tellers look good.

Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

While it may be tempting to listen to those who prognosticate the best stocks to buy or the future direction of the market, it is important to remember that the data refutes their ability to improve your investment decisions.

Market experts are not regulated. There is no licensing body or minimum level of education to call yourself a market expert and start making predictions. Even if there was, the evidence shows that no level of education or intelligence makes it possible to beat the market consistently. Markets experts should be viewed as nothing more than they are: a source of entertainment.

I’d love to read your thoughts and questions about this video in the comments.