Two Silly Predictions You Should Ignore

Display boards at the Australian Stock Exchange flash news of a falling market in Sydney, Friday, Sept. 23, 2011. Pacific sto
Display boards at the Australian Stock Exchange flash news of a falling market in Sydney, Friday, Sept. 23, 2011. Pacific stock markets are down sharply in early trading following big losses on Wall Street amid growing fears of another global recession. (AP Photo/Rick Rycroft)

Investors suffer from the perfect storm of collective amnesia and cognitive dissonance when it comes to evaluating the predictions of self-styled stock market gurus. It's disturbing that these predictions are so casually made by people who know they will have a negative impact on many who follow them. They engage in this charade to keep their names in the news in an attempt to burnish their fortune-telling credentials and generate assets.

The CXO Advisory Group performs a great service to investors by keeping track of the accuracy of stock market predictions. You can find their analysis here. They conclude these experts are right around 50 percent of the time, which is just about what you could expect by flipping a coin. There is no peer-reviewed data indicating that anyone has demonstrable skill (as opposed to luck) in predicting the direction of the markets.

This week, Bill Gross, the so-called "King of Bonds", who runs the world's largest bond fund (PIMCO), observed that "the cult of stocks was dying." According to Mr. Gross, stocks operate much like a Ponzi scheme, with returns unrelated to reality.

Before you dump your stocks based on this dismal prognostication, let's look at the predictive track record of Mr. Gross. According to one report, at the end of the second quarter of 2011, Mr. Gross predicted that bond yields would increase significantly. Bonds are his area of special expertise. That didn't happen. Investors in Gross' bond fund got clobbered. As of October 15, 2011, the fund ranked 536 out of 584 comparable funds. Mr. Gross sent a letter to investors admitting that he had "misjudged the fly ball", causing returns for the year to be "a stinker."

Mr. Gross may turn out to be right or wrong. But he has no special predictive powers.

The CEO of Morgan Creek Capital, Mark Yusko, hopped on the bandwagon. He told advisors to expect no significant returns from equities through 2021(!). Mr. Yusko suggested advisors were "brainwashed" by the teachings of John Bogle, who advocates focusing on capturing market returns using low cost index funds.

Mr. Yusko supports his view by finessing the data. He uses the returns of the S&P 500, noting that: "[S]ince 1999 the return on stocks is zero." What's the alternative? Mr. Yusko advocates high fee hedge funds and private equity.

There are several glaring problems with these views.

First: Allan Roth totally demolished the idea of a "lost decade" in this excellent blog. Roth correctly notes the returns of the S&P 500 ignore dividends, leave out a lot of stocks (especially international stocks) and ignore bonds. I know of no advisor who recommended that 100 percent of her clients' assets be allocated to a stocks in the S&P 500 index.

Second, the track record of hedge funds is mixed at best. According to an article in The Economist, as of December 3, 2011, the average hedge fund had fallen by around 9 percent year-to-date, as compared to a loss of only 3.4 percent for the S&P 500.

Huge hedge funds often follow a "boom and bust" cycle. You can find a list of "The 10 Greatest Hedge Fund Implosions of All Time" here. How is an investor supposed to select the next hedge fund "winner"?

While Mr. Yusko's alternative strategies appear to have very little data to support them, there is a better way to invest, which has reams of academic support. I recommend this extremely insightful blog by Brad Steiman, a Vice-President of Dimensional Fund Advisors, entitled "The Greatest Hits of Investing", to all investors. It nicely describes fundamentals of investing that can be easily understood and implemented. You will find it to be in sharp contrast to the musings of Mr. Gross and Mr. Yusko, and to most of what you hear in the financial media.

Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read, and The Smartest Portfolio You'll Ever Own. His new book is The Smartest Money Book You'll Ever Read. The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.