The Perils of Prognostication

This past week's market machinations pushed the point even further.  

As Barry Ritholtz noted (the chart above came from his excellent blog, The Big Picture), Rule #9, from Bob Farrell's Market Rules to Remember, states as follows:  "When all the experts and forecasts agree—something else is going to happen." The S&P 500 closed last week (Aug. 5, 2011) at 1199.38, a drop of more than 10 percent since the end of the Fed's second easing program (QE2) and substantially below even the lowest year-end prediction listed above. 

As it stands today (remember, however, that a lot can still happen before year-end), none of these experts looks likely to be right or even close.

This is not to say that market performance is entirely random and in no way predicated upon value.  As I wrote in my Investment Outlook 2011 back at the beginning of January (available here):

"Even though the majority of analysts are proclaiming that all is well in the financial markets and that investors should expect outstanding returns in 2011, I am decidedly less sanguine. Serious questions remain about both the existence and depth of the purported economic recovery nationally and globally. I am also concerned about the extent to which the economy and the markets have been propped up via government action, inaction and intervention.

"For a true recovery to take place, we need changed behavior at the governmental level and we can use it at the individual level too. We are not saving enough. We are not planning enough. We are not careful enough. Without serious and significant change, something has got to give. Because I am skeptical that significant change will happen or will happen soon enough, I can't join the ranks of the bulls."

As I pointed out then, "[i]t is hard to stand alone. It is dreadful to be wrong alone. But doing what is best for clients requires making some tough calls and some tough choices. The herd says 'Buy.' I say, 'Be careful.'" 

More specifically: "The anticipated clear sailing could indeed come to pass and might even last for a good while—perhaps all year. But such favorable market conditions will only last until, inevitably, they don't. When it comes, I expect the change to be rapid and the drop deep. Economic and market difficulties create a variety of risks and problems. But they also create tremendous opportunities. I therefore encourage investors to remain skeptical, cautious, defensive and opportunistic. In 2011, investors should look to take advantage of the opportunities that present themselves while carefully managing and mitigating risk."

In a secular bull market, one's primary goal should be maximizing returns.  In a secular bear market (like we face now), the key goals are to preserve capital and to mitigate risk.  Doing so is not easy.  Indeed, although my Outlook looks pretty good today, it could all blow up in my face at any time. 

As John Maynard Keynes famously pointed out, "The market can stay irrational longer than you can stay solvent." So beware of predictions—mine included.  Even so, it still makes tremendous sense to plan and prepare (carefully) so as to find value in a precarious marketplace.