The coronavirus has had an unprecedented impact on our lives and the global financial markets. And while it’s normal to look towards market experts for guidance during these times, be wary. Market predictions make for catchy headlines, but they’re usually poor investment guides.

‍

“Prediction is difficult, particularly when it is about the future” -- Mark Twain 

What Happened This Past Month?

The S&P 500 registered its fastest 30% drop in recorded history on March 23rd. It took just 23 trading days to erase ⅓ of its value. Brands we know and love, like Nike and Disney, had lost 40% and 31% of their market value, respectively. On March 23rd, the whole world seemed to be falling apart and experts had plenty of ideas on where the market may head, including that stocks could fall an additional 50-60% before rebounding.

Then, the tide seemed to turn. The S&P rose more than 22% from its March 23rd lows. Congress passed a $2T spending bill, and the Federal Reserve announced that it would  lower interest rates and purchase financial instruments such as ‘junk bonds’. At the time of this writing, stocks are only down 16% from their all-time highs.

The Public's Reaction

As expected, the market drop caused massive panic for the average American. As many saw a ⅓ of their retirement funds disappear, Google searches for “stock predictions” peaked the week before the S&P bottomed. But unfortunately, market predictions are poor tools to help investors grow wealth because they are usually wrong.

A Warning - Be Skeptical

Market predictions are often wrong for a few reasons. 

First, consider the incentives of the authors. Market predictions that are outlandish often catch more attention, and that attention leads to more clicks.

Predictions from 36 of the “top ranked market timers” for last year’s Dow Jones performance were often inaccurate. On average, they predicted that the Dow Jones would return 4.5% in 2019. One prediction included a drop to 14,000, a level not seen since early 2013. But instead, the market rose more than 25%, peaking above 28,600. This phenomenon isn’t isolated to one year, however. A 2010 analysis by the BAM Alliance shows that merely 32% of ‘sure bets’ turned out to be correct. 

Secondly, market returns are inherently hard to predict because they are ‘fat-tailed’. This means that stock return distributions do not follow the normal bell curve we were taught in high school statistics. Under the normal curve, 99.7% of data are within 3 standard deviations of either side of the mean value. In addition, normal curves don’t have fat tails, meaning that it is ‘easier’ to predict a value, since most values fall around the average. A common example is SAT scores. If someone were to task you with guessing another person’s SAT score, without knowing anything about the test-taker, your best guess would be the average.

Market returns, on the other hand, are much more variable than a normal curve would suggest.

Some Historical Context

In “The (mis)behavior of markets: a fractal view of risk, ruin and reward”, Mandelbrot and Hudson show the failures of the normal curve in describing market performance by writing:

“From 1916 to 2003, the daily index movements of the Dow Jones Industrial Average do not spread out on graph paper like a simple bell curve. The far edges flare too high: too many big changes. Theory suggests that over that time, there should be fifty-eight days when the Dow moved more than 3.4 percent; in fact, there were 1,001. Theory predicts six days of index swings beyond 4.5 percent; in fact, there were 366. And index swings of more than 7 percent should come once every 300,000 years; in fact, the twentieth century saw forty-eight such days.”

Final thoughts

People who issue market calls have a nearly impossible task. Predictions are most likely wrong and should be taken with a hearty grain of salt, given what we know about the history of markets.

‍
It’s natural to want to know where the stock market will go when the world seems to be breaking at the seams. However, I hope that this article serves as a reminder that most stock predictions are meant to attract attention, rather than provide accuracy. The math is not on the side of the predictors and history should serve as a lesson that even our best experts are likely to be wrong. Therefore, your buy and sell decisions should not be based on a few, evocative articles.

Photo by Lorenzo from Pexels