Don't Fear the Reaper

August 6, 2014 1:07 PM

Amid the endless speculation of whether the market has topped and is heading lower, remind yourself of one thing—when was the last market top called broadly by the media or market pundits?  Almost never. A few people have become famous by calling a market top, but most of them went on to ignoble and often very wrong additional market predictions. Indeed, there is a whole category of “one-Hit wonders” when it comes to market prognosticators and for good reason—there is no verifiable method to correctly call market tops and bottoms. Over the span of my entire career, I’ve investigated dozens of methodologies for pinning market tops and bottoms, and have found very little that you can test over many market cycles that work. Those that have added value tend to be trend following systems, but they never get you out or into the market at a top or bottom.

Philip Tetlock found in his book Expert Political Judgment: How good is it? How Can We Know?  that the record of so-called experts at making forecasts over a variety of subjects was virtually no better than chance. His study covered a 20-year period that looked at 284 experts who made 28,000 predictions about the future, and they might as well have been flipping coins. Indeed, the predictions were worse than simple computer algorithms, most likely because the computer algorithms always applied the same formula time-in and time-out. I’ve written extensively about this and the first several chapters of my book What Works on Wall Street  as well as my last post cover why models beat humans. My son, Patrick O’Shaughnessy, also a contributor addresses this in his post Beware Experts Bearing Predictions

So where does this leave us? Instead of listening to all of the talking heads issuing dire forecasts, we should remember that market corrections of 5% or more are very common. Since January 1st, 1926, there have been 39 such corrections (see table below) but note well—every single correction was followed by the market recovering and going on to new highs. Unless you believe that the United States is entering a period of continual decline, U.S. Stocks should be part of your long-term investment portfolio. They shouldn’t be the only part however. We live in a global marketplace, and there are many very attractive stocks that are outside of the United States. My advice for long-term investors remains unchanged, instead of fearing market corrections, you should use them as buying opportunities and you should do so on worldwide basis. Far from fearing corrections, you should embrace them as an opportunity to buy stocks while they are on sale. 

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