crystal ball

how to predict the stock market

Note:  This post was originally written in March 2008 (before the, ahem, “problems”), but I’ve updated it slightly for today’s conditions.  It’s amazing that when I originally wrote how to predict the stock market, it was contrarian advice, and a few commentators took me to task on my semi-prediction that double-digit returns couldn’t continue.  What’s funny is that 10% was the commonly used return on investments cited by most bloggers pre-2008, including probably more than once yours truly.  It’s amazing to think how poorly humans predict the future.  I’ve added more commentary at the bottom.

Back to my past attempt at predicting the stock market…

Quoting directly from an annual report is not something I’ve done before on Brip Blap, but I thought this little nugget from Berkshire Hathaway’s CEO Warren Buffett was worth sharing. Friday’s [2007] annual report to shareholders is available on Berkshire Hathaway’s website.

From Fortune:

[Buffet] writes that the Dow Jones Industrial Average surged from 66 to 11,497 during the 20th century. That is a huge rise – yet it averages out to just 5.3% compounded annually, Buffett writes. What’s more, were the DJIA to repeat that 5.3% average annual gain throughout the 21st century, its value on Dec. 31, 2099, would approach 2 million.”It’s amusing that commentators regularly hyperventilate at the prospect of the Dow crossing an even number of thousands,” he writes. “If they keep reacting that way, a 5.3% annual gain for the century will mean they experience at least 1,986 seizures during the next 92 years. While anything is possible, does anyone really believe this is the most likely outcome?”

If that scenario isn’t outlandish enough, Buffett goes on to note that were stocks to return 10% annually throughout this century, the Dow would hit 24 million by year 2100. “If your adviser talks to you about double-digit returns from equities,” he writes, “explain this math to him – not that it will faze him. … Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.”

I’ve written about this before. I am constantly amazed at the optimism people bring to the concept of long-term guaranteed double digit returns in the stock market if you invest in index funds. I am even more amazed that people hope for the US market to continue at these rates of growth, since I think the explosive days of US growth are behind us, as a country. The simple truth is that unless you are a very good investor (and they exist – I don’t deny that) you probably can’t beat the market. 75% of mutual fund managers can’t, either. What is most likely is that you can count on a before-tax return of less than 6% per year – before taxes.

I know the DJIA is probably not the best single measure of returns, and I know different time spans would result in different return rates, and I know there are variables such as tax treatment, dividends, etc. that might affect this calculation. But the best investor in America (if not the world) thinks that counting on the general return of the market to exceed 5.3% is foolish, and I have to pay attention to his opinion since he seems to have a good understanding of investing, to say the least.

I use the “index fund method” of investing, buying broad-based index funds that mirror the performance of the market. If I look back in 20 years and see 5.3% returns per year I will kick myself for not buying CDs instead and avoiding the volatility which is giving me nightmares today. I sometimes wonder if I do need to put more effort into actively picking stocks, instead of hoping for the lift and swell of a troubled, debt-ridden country’s over-regulated stock market to carry me to retirement. It’s enough to make you sleepless at night in times like these.

Back to the present where I again try to guess how to predict the stock market….

 

Now, if you’ll re-read that last paragraph, you’ll note one bit of stupidity on my part.  Can you guess it?  I’ll give you a hint – if you’ve read my blog over the past few years, do you think I still complain about an over-regulated stock market?  I don’t even know why I said it then, except that I was caught up in the hideous mess that was Sarbanes-Oxley – a boondoggle for consultants and auditors if there ever was one.  SOX was over-regulation in the sense that it required a huge amount of work and produced (in my opinion) almost no improvement in corporate governance or controls (see: 2008 Wall Street meltdown and bailouts).  To the best of my knowledge all the big Wall Street disaster firms were fully SOX compliant.  So I’ll give myself half a pass there.  But it’s clear over-regulation has never been the problem.  Maybe under-enforcement is, but over-regulation?  Nooope.

What do we have to look forward to in the future?  The stock market has returned roughly 40% since Obama took office.  40%.  With unemployment up, debt up, trust in our institutions down, the stock market still goes up.  Is it confidence in Obama?  Confidence in Wall Street?  Or is there simply nowhere else to go?  Real estate and “high yield” savings accounts are battered and broken.  CDs are laughable, and paying down a mortgage at 3.5% interest seems misguided.

Part of me says it’s all smoke and mirrors, and part of me says “if you can’t beat them, join them.”  You make your own decision, of course, but the only thing we can be certain of is that the future is uncertain.  I cynically sometimes proclaim that the only sure investments are canned goods, shotguns and shells.  But the reality is that the market will go up because that’s where the money is, and we won’t have much choice except to follow it (unless we want to attempt various early retirement options, which may be the best answer).

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  • http://hopetoprosper.com Bret @ Hope to Prosper

    I agree the investment returns on the stock market likely won’t match the returns from the 80s and 90s. Although many companies are highly profitable right now, these are a lot of drags on the market. Most important, the dollar is declining, a lot of Baby Boomers are retiring and global government deficits are undermining the world’s economies. These trends are going to last for decades.

    I wish there was an attractive alternative to the stock market.