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It’s Not the Bear You See





“It’s not the bear you see. It’s the one that jumps you from behind you have to worry about.” – Classic hunting wisdom

At any point in time, there is a general mood and a popular forecast about what will happen. The popular media and most investors generally have the same future expectations.

The surprising truth, however, is that these popular forecasts rarely happen.

Believing popular forecasts can have significant consequences. It leads investors to make the wrong guesses in their investment decision-making process which can be seen in the “Behavioral Gap” – consistently buying high and selling low.

“The majority is always wrong.” 1

Most experienced investors that have been around the markets for a decade or more have learned to take popular forecasts with a lot of skepticism. Instead, they focus on the valuation of the underlying investments to guide their investment decisions. The wisdom that investors need to learn is that: “The majority is always wrong.” 1

Even less accurate are popular forecasts of major financial catastrophes. The major financial catastrophes that actually happened in recent years were not widely predicted. It’s not the bear you see that you have to worry about.

Here are the most popular forecasts on New Year’s Day in recent years:

Popular Forecasts in Recent Years

Year Most Popular Forecast on New Year’s Day Did it happen?
1999 Y2K millennium bug will crash many computers. No
2000 DOW 36,000 – 25% per year growth will continue. Buy Nortel No
2001 We had a small correction. NASDAQ & DOW will soon be back to their highs No
2002 Recovery will start in spring. The market recovered after 9/11. Recession is shallow. No
2003 Fear. Avoid stocks. SARS will have a major economic effect. No
2004 2003 was a “dead cat bounce”. A “double dip recession” is likely. No
2005 US real estate boom will continue. No
2006 Income trusts will continue to soar. Which company will convert to an income trust next? No
2007 Continuing of “Goldilocks economy”. US real estate downturn won’t affect the economy. No
2008 We are running out of oil. Oil will reach $250 per barrel. Canadian dollar will reach $1.20. No
2009 Panic. The financial system will collapse. DOW will fall to 5,000. No
2010 We are in the “Great Recession”. A “double dip recession” is likely. H1N1 virus. No
2011 Europe will collapse because of the PIIGS (Portugal, Italy, Ireland, Greece & Spain) No
2012 Europe will collapse. Austerity and “age of deleveraging” will lead to years of low growth. ??

Notice how consistently the popular forecasts are wrong?

The surprising part and what I personally find most staggering, is not that they rarely happen, but that most investors always believe the latest one will happen this time. If the last 14 popular forecasts were wrong, why does everyone believe the latest one?

There are many reasons these popular forecasts are so consistently wrong. The main reasons are:

1. Assuming trends will continue

Most popular forecasts merely extrapolate current trends into the future. They are really true of last year, not of next year. Human brains naturally assume trends will continue, even though nearly everything in the financial world goes through cycles.

For example, there were a lot more people forecasting a market crash in the years after the 2008 crash than before the crash happened.

2. Assuming nobody will do anything about issues

Forecasts of financial collapses always assume that nobody will do anything. Everyone with authority to deal with the issues will just stand around and watch.

For example, the current forecasts of a financial collapse in Europe assume nobody will be able to prevent it. Solutions to the issues in Europe, such as Eurobonds and a common bank guarantor are well known, but the politicians are taking a long time to negotiate them. However, if necessary they will do whatever it takes to maintain stability. Why would everyone assume politicians and financial authorities will stand around while Europe collapses around them?

3. Not realizing that markets already “price in” known information

Mass opinions are already “priced in” to investments. Today’s prices for investments are based on all the known information and expectations about what investments are worth.

For example, when everyone expects a market crash because of Factor X, then the prices of stocks already assume that Factor X will happen. Most investors fail to realize that if Factor X does actually happen, it will likely have little effect because markets had already priced it in. Any effect of Factor X on the markets already happened.

4. Valuation matters

Popular forecasts focus on trends and events, and generally ignore how cheap or expensive various investments are. Never forget – eventually valuation matters.

For example, during the tech boom around 2000, the technology industry made amazing claims, such as that in about 10 years internet traffic would be millions of times higher and that there would be more handheld devices on the internet than computers. Most of these claims have come true, but the technology-heavy NASDAQ index is still valued at half of what it was then. This is because the prices of technology stocks in 2000 included all the expected growth (and more) and were hugely over-valued.

Today’s Popular Forecast

Today’s popular forecast goes something like this: The stock market will go nowhere for the next 5 or 10 years because we are in an “age of deleveraging”. Austerity (government spending cuts) around the world will keep growth very slow and unemployment high. Europe will continue to struggle and the European Union may collapse. Greece may leave the European Union, and Spain and Italy are next. So you should stick with investments that “pay you to wait” by paying interest or a dividend or some kind of yield.

Sound familiar? This view is all over the financial news and blogs.

Will it happen? The simple fact that forecast is popular makes it doubtful.

There are many possible outcomes. The popular forecast is by no means inevitable.

I recently attended a talk by Niels Veldhuis, the president of the Fraser Institute. His main thesis was that when Canada went through deleveraging and austerity, it led to higher growth. In the mid-90s, Canada had run up a huge debt and there was speculation as to when we would hit the “debt wall”. Then we cut back spending and paid down the debt. Greater confidence in our finances and less government promoted growth. In Canada, it did not lead to years of low growth.

What can we learn from this?

1. The simple fact that a forecast is popular makes it doubtful.

I just returned from 3 conferences. At one, there was a panel of 5 good investment managers and about 2,500 financial planners in the audience. One of the investment managers said that he did not expect interest rates would go up in the next couple of years. After a general murmur of disapproval went through the audience, he said: “Do you want to know why I think that? How many of you here think that interest rates will go up in the next couple of years?” Virtually every hand went up. He said: “There is a forest of hands up. That is why I don’t think that will happen.” 2

2. Never forget – eventually valuation matters.

Popular forecasts are far more useful as a measure of current market sentiment than as actual predictions. They tell us which sectors of the market may be overvalued or undervalued due to the current sentiment.

For example, investors everywhere are “chasing yield” today. That makes most yield investments, such as bonds and dividend paying stocks, priced higher than normal. Even if news is favourable for them, their future returns are likely to be lower because they are not cheap today.

At the same time, today’s popular forecast is that there will be little growth in the next few years, so growth investments, such as stocks and equity mutual funds, are relatively cheap.

The best investments are usually in undervalued sectors – not the popular sectors. Because of their valuation, the best investments are rarely the ones you would expect based on the popular forecast.

3. Don’t follow the herd.

The cost of investing based on popular forecasts, in most cases, is reduced investment returns because you are not investing when markets are undervalued. Despite the fact that it is logical to buy low and sell high, many studies show that most investors consistently do the opposite. This “Behaviour Gap” wipes out about 2/3 of long term investment growth of the average investor. 3

Key investment wisdom to remember:

  1. It’s not the bear you see that you need to fear.
  2. The majority is always wrong. 1
  3. The simple fact that a forecast is popular makes it doubtful.
  4. Market trends usually reverse. Markets go through cycles.
  5. Never forget – eventually valuation matters.
  6. Don’t follow the herd.

1 “In economics, the majority is always wrong.” John Kenneth Galbraith

2 Just because a forecast does not happen, it does not mean that the opposite will happen. There are many possible outcomes. The fund manager in the story is not expecting interest rates to go down. He is expecting they will take more than a few years before they go up.
3 “2012 QAIB – Quantative Analysis of Investor Behavior”, Dalbar, Inc.

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com.  You can read his other articles here.





14 Comments, Comment or Ping

  1. Although I listen to the information, I keep true to my own goals. I still dollar cost average into the market in good and bad times. I keep a reasonable asset allocation and try to be diverse enough that I am moving forward. I guess I am going my own way!

  2. 2. pds

    Ed: Great article. Well thought out and written. Thanks.

  3. 3. Andrew

    Fantastic post! Love the list of popular forecasts that proved not to come true.

  4. 4. Ed Rempel

    Hi Krants,

    Your method makes perfect “cents”. Ignore the media and the popular sentiment for making your investing decisions. Popular forecasts are extremely inaccurate and should not be a basis for investment decisions. It is much more effective to stay focused on your long term goals.

    Ed

  5. 5. Miiockm

    H1N1 killed 18,000 people.

  6. Great article Ed….another good lesson to forget the popular noise.

    Mark

  7. 7. Goldberg

    Good article. Made me think.

  8. I believe that marketing forecasts is also a marketing strategy to encourage people to invest or buy shares of a particular company. Though I listen to these forecasts, I try to stick to my own forecast.

  9. 9. Ed Rempel

    Hi Miiockm,

    Yes, H1N1 killed many people, but it did not have a significant effect on the stock market, other than creating fear for a few months. There was fear of a major outbreak or “pandemic” that would have a major effect. There were news documentaries comparing it to past pandemics.

    But of course, it did not happen.

    Ed

  10. 10. bob

    Oh man.

    How, exactly, are you measuring which predictions are “the most popular”?

    It would be pretty easy to go back and find an equal number of “popular predictions” that did come true.

    Pretending that there is a general rule that “If it is popular it is wrong”, is dangerous nonsense.

  11. Actually, when it comes to the stock market, ‘popular is wrong’ is a pretty good rule of them. Heck, I recently saw a post (globe and mail I think) of someone advising another poster to stay away from the stock market because it was too volatile and down right now. Unfortunately it’s pretty clear that this is the general belief out there. Apparently most people still don’t actually get ‘buy low, sell high’ in practice. And apparently most poeple don’t seem to understand that in reality, sitting out right now when the stock market is low and waiting for things to get better before buying is the very definition of buy high sell low.

    Either way, agree or disagree with Ed, he always has well written and more importantily, well thought out posts. Definitely one of the more educational posters in the field.

  12. 12. Ed Rempel

    Hi bob,

    The popular forecast I listed for each year was the most popular, as far as I know. I was around during all those years and remember the general mood and most common news stories for most years. I also looked up the main news stories of each year.

    At any point in time, there are a variety of groups predicting a variety of things, some of which happen and some don’t. I am referring to the mood of the general public, the most common news and the popular wisdom that the financial industry is emphasizing.

    Can you think of any forecasts as popular as the ones I listed that did happen?

    My point here is that most people believe these forecasts and take them as inevitable. Then they make the mistake of basing investment decisions based on them.

    It is much better to ignore popular forecasts because: “The simple fact that a forecast is popular makes it doubtful.”

    Ed

  13. 13. Ed Rempel

    Hi Everyone,

    Thanks for all the kind comments.

    I’m surprised that nobody is sticking up for today’s popular forecast, though. I was expecting a bunch of people to say Europe will probably fall apart and if not, then obviously all the “austerity” and “age of deleveraging” will mean that growth and stock market returns will be very low for many years. It’s inevitable.

    This is all the news. Perhaps I am wrong that this is the popular forecast. Is nobody going to defend today’s popular forecast???

    Ed

  14. 14. SST

    Just as market timing is a difficult task to achieve with accuracy, so is forecasting.

    We still have yet to see the conclusion of the stories from 2007 (the start of the Great Recession) and beyond. Government intervention is a great interruption of the inevitable; thirty years of games takes a long time to play out.

    But you are correct, it’s not the bear you see (eg. lower real estate markets), but the bear which jumps you from behind (eg. contamination of ALL markets via interest rate fraud, collusion, and manipulation) which is the real killer.

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