Why Predicting the Stockmarket is a Fool's Game

At Lorica Partners, our advisers regularly remind clients of a fundamental truth: predicting short-term movements in financial markets is virtually impossible. To support this advice, we periodically need to provide evidence.

Given the US stockmarket represents around 65% of the global market, and we have data going back 99 years to 1926, it serves as a robust dataset for illustrating market unpredictability.

The Challenges of Accurate Predictions

The first graph looks at equity analyst predictions for the US stockmarket from the most reputable US institutions at the beginning of 2024.  The median forecast for the S&P 500 index was a modest +1.7% for the 12 months ahead.  The JP Morgan analyst was quite pessimistic, predicting a significant -12% decline.

Source: Dimensional Fund Advisors

Contrary to these forecasts, the market defied expectations with a remarkable +23% gain by year-end. Even the most optimistic predictions fell short, indicating the challenge of predicting short-term market behaviour. But those analysts expecting negative returns likely advised their clients to move from the stockmarket to cash at the beginning of 2024. How much did these clients miss out on? -

The issue of missed predictions is not limited to a single year. If we look at the past five calendar years, analysts consistently missed the mark in forecasting market outcomes. As shown in the graph, the yellow dots represent actual market returns, while the blue squares represent the median predictions. The consistent gap between the two underscores the unpredictability of market movements.

Source: Dimensional Fund Advisors

Most analyst predictions for annual S&P 500 index returns are between 0% and 12.3%, which is the long-term average annual return of the S&P 500 index since 1926.  You might think making a prediction within this range is a safe bet.  The historical data suggests otherwise.

Historical Data: The Unreliability of Predictions

In fact, of the 99 years of data we have for the S&P 500, only 7 years (less than 8% of the time) saw returns fall within +/- 2% of the long-term average, which is a range of 10.3% to 14.3%. Conversely, in 45 years (or 45% of the time), the market saw returns of +20% or greater, or losses of -20% or more. This highlights the erratic and often unpredictable nature of the market.

Source: Returns Program

While it is possible to calculate an average return for the US stock market over the past century, these annual returns are rarely close to the average. Instead, they tend to be sporadic, with no discernible pattern.

But if over the longer-term you average returns around 12%, this means you double your money every 6 to 7 years. You could have achieved this without guesswork or allocating your precious time away from what really matters to reading the Business section.

The Limits of Predictions

Given this evidence, when someone claims to know what the stock market will return in the next 12 months—regardless of their experience or tenure in the financial services industry—it’s wise to be cautious. As Warren Buffett famously said, attempting to predict the market in the short run is a "fool's game."  We agree.

The Value of Long-Term Thinking

Instead of focusing on short-term market predictions, it is far more prudent to adopt a long-term investment strategy. As Buffett also said, "The stock market is a device for transferring money from the impatient to the patient." This is where the real opportunity lies—investors who can tolerate short-term volatility and focus on long-term growth are better positioned to succeed in the stock market.

Remember – uncertainty is your friend.

The inherent uncertainty of the stock market means that there will always be a degree of risk. However, with risk comes the potential for higher returns. Those who understand how to manage risk effectively—whether through diversification, proper asset allocation, or simply sticking to a long-term strategy—are in the best position to harness the rewards of the market’s unpredictable nature.

 

Author: Rick Walker

Rick Walker