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Can experts predict market turning points?

“Buy low, sell high” sounds like a wildly simple and effective investment strategy. But it requires an investor to know when is a good time to buy, and how to time the even harder decision to sell. Can investors predict and profit from turning points in markets? Can experts help with this decision making?

Thursday, July 13th 2017, 9:00AM 1 Comment

by Pathfinder Asset Management

The market’s prediction power

It seems logical to expect equity markets to fall if the economy hits a recession. If investors as a group are skilled at predicting the future, then a bear market should precede each recession. In a 1966 Newsweek article, economist Paul Samuelson famously remarked that the stock market had predicted nine of the past five recessions. His tongue-in-cheek comment actually holds true – in 13 post-war US equity bear markets there have been only seven recessions within 12 months (source: CNBC). That’s a 53% hit rate – or essentially about the same as a coin toss.

This indicates that the market (i.e. investors acting in aggregate) may not be a great predictor of downturns. But what about as individual investors – is it possible to time the market and pick turning points? Can experts help?

Listen to the experts….

During the Brexit debate, MP Michael Gove (the UK Justice Secretary) controversially said “people in this country have had enough of experts.” Whether we agree with expert views or not, we need to hear a diversity of credible views to challenge and shape our own thinking. 

But there are traps with relying on expert opinions. One is to pick up on a market forecast that an expert has been espousing pretty much in perpetuity. Eventually, it will be right and they will claim to have forecast the market turning point. Commentators such as Jim Rogers are perpetually predicting the next crash in developed market equities (Rogers founded the Quantum Fund with George Soros in the 1970s). Ben Carlson, an investment manager and financial author, recently published a list of headline comments from Rogers over the last seven years predicting a market meltdown:

2011:   100% Chance of Crisis, Worse Than 2008: Jim Rogers
2012:   Jim Rogers: It’s Going To Get Really “Bad After The Next Election”
2013:   Jim Rogers Warns: “You Better Run for the Hills!”
2014:   Jim Rogers – Sell Everything & Run For Your Lives
2015:   Jim Rogers: “We’re Overdue” for a Stock Market Crash
2016:   $68 Trillion “Biblical Crash” Dead Ahead? Jim Rogers Issues a dire warning
2017:   Legendary investor Jim Rogers expects the worst crash in our lifetime

Carlson's take out is clear - "Rogers very well may be a legendary investor but that doesn't make his crystal ball clearer than anyone else's."  Markets have a habit of fluctuating over the medium-term, but essentially following a long-term trend. This means markets are likely to “mean revert” over long horizons. If for seven or more straight years you predict the end of a bull market and a significant fall, you should eventually be right.

Take care with ambiguity and context

Expert views can often be misinterpreted. In the 6th century BC, Croesus (ruler of the Kingdom of Lydia, now Turkey) consulted the Oracle of Delphi in relation to a proposed war with the Persians. Should he attack and start the war? The Oracle’s answer was that if he started the war, a great empire would be defeated. Croesus took this as a prediction he would crush the Persians. Unfortunately, the forecast was ambiguous and Croesus’s own empire was soundly beaten. The Oracle’s prediction would be right regardless of who would win!

Fence-sitting and ambiguity is entirely understandable when giving a forecast. Here’s a great recent example from Nobel Prize-winning Robert Shiller with his view on where markets are currently heading. He says, "I think it's a time for caution - but the market could go up substantially."  Nothing like hedging your bets – his view is kind of right whether markets go up or down.

The context of an expert view needs to be taken into account. Picking up on the sound bite conclusion may mean more detailed reasoning and nuances are overlooked. For example, in relation to Robert Shiller’s quote above, in the same interview he said:

  • There are areas of the market that are currently undervalued, such as consumer discretionary, industrials, healthcare and technology (i.e. there are some pockets he’d be buying)
  • His fundamental problem is not a simple prediction of whether the market will go up or down, but rather trying to predict whether Trump will deliver on promises. He thinks if Trump delivers, then the economy will be stronger and markets will likely go up.

Another trap with expert views is they can play to investing behavioural biases. “Authority bias” is the tendency to attribute greater accuracy to the opinion of an authority figure. “Confirmation bias” involves putting more weight on an expert view that is consistent with your own. These can lead us to become overconfident in our reliance on an expert’s view.

So, experts: are we at a turning point?

It’s easy to make a call on whether right now we are at a turning point; it is another matter whether the call will prove to be right. Deutsche Bank recently published a paper titled, “Financial markets entering frothy territory.” They note the stock market capitalisation relative to GDP is close to previous peaks of 2000 and 2008.  They see the approaching monetary policy turnaround (i.e. raising interest rates) as the likely catalyst for lowering risky asset valuations and raising safe asset valuations.

Other experts have a more brutal assessment of an impending crash. Mark Faber (known as 'Dr. Doom') told CNBC that “investors are on the Titanic”, and will soon “endure a gut wrenching drop that would rival the greatest crashes in stock market history.” John Hussman, a Stanford University economics PhD and mutual fund president, agrees we are facing “the most broadly overvalued moment in market history.” Not so long ago, the Royal Bank of Scotland told their clients to “sell everything”, because “in a crowded hall, the exit doors are small.” Sounds like we should dump equities and run.

But it’s not all bad news. Let’s consult a different collection of experts. We could side with the JP Morgan Strategist who told the Telegraph that, going forward, we have “continued smooth sailing for shares.” Or we could listen to Fiona Cincotta, market analyst at City Index, who said ,“I am looking optimistically at the FTSE for the year”, and predicted it could finish 2017 almost 20% higher than current levels. Then there’s Jeffrey Kleintop, chief global investment strategist at Charles Schwab, who believes tailwinds will continue for equities and “should help stocks make some decent progress” through 2017. Merrill Lynch's Savita Subramanian was so daring as to suggest that 2017 could see the S&P500 gain up to 20% (it is so far up almost 10%).

So, whether we are personally a bull or a bear we can find an expert to confirm our view. In fairness, it was easier to find experts predicting an imminent market fall than experts saying the current market would keep rising. Not sure if that tells us something about market valuations and direction - more likely it simply tells us that messages of doom make better media headlines.

Final thoughts

The aim of this commentary is to generate discussion rather than provide answers. Here’s some points to ponder in relation to your position on market turning points:

  • Do you trust any expert calls on timing markets?
  • Do you have your own rule for trying to predict market turning points?
  • Is “time in the market” better for returns than trying to “time the market”?
  • Can experts who look widely and think deeply make better decisions than your average investor? (Or is the potential to overthink things actually a handicap?)

Finally, if you have either found an expert or developed your own process that accurately and repeatedly calls market turning points – please let me know immediately!

John Berry

John Berry is a founder of Pathfinder Asset Management Limited and is an independent director of Punakaiki Fund Limited. This commentary is not personalised investment advice - seek investment advice from an Authorised Financial Adviser before making investment decisions.

Pathfinder is an independent boutique fund manager based in Auckland. We value transparency, social responsibility and aligning interests with our investors. We are also advocates of reducing the complexity of investment products for NZ investors.

Tags: equities investment Markets Pathfinder Asset Management

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Comments from our readers

On 18 July 2017 at 6:35 am Peter Urbani said:
The only person that has had any degree of repeated success in predicting crashes is Didier Sornette the author of Why Stockmarkets Crash. His log periodic formula posits that anything that grows at a faster than exponential rate goes to infinity in finite time and must therefore deflate or crash. The methodology correctly predicts '87 and '07 and many others but unfortunately over-predicts by about 30% (false alarms or bubbles that deflate without crashing ).

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