One of the basic tenets of the Strategic Approach to investing is that it is very difficult to predict future movements of securities or securities markets. As matter of fact many academic studies over many years have demonstrated that Wall Street and its army of professionals who earn a handsome living trying to pick winning stocks and forecast market movements are really not very good at it.
Alfred Cowles, III was one of the early pioneers of performing extensive research on just this topic. He was a Yale graduate and founder of The Cowles Commission at Yale in 1932. Cowles began his research because he learned the hard way about following the noise of the Wall Street crowd.
Cowles came from a very wealthy family who owned the Chicago Tribune. His family put him in charge of managing the family fortune. He took this responsibility very seriously, and spent all of his time poring over reports of analysts from the leading brokerage firms, banks, insurance companies, and market letters. However, in the fall of 1929 the stock market crash severely damaged his family’s fortune. He pondered, why did this happen? I followed the advice of Wall Street’s leading professionals, and not one of them predicted the crash. He decided that he was going to take a different approach and joined with other leading economists of the day, including Benjamin Graham, to found the Econometric Society.
His first effort was to do a very detailed study of Wall Street’s predictions for stock selections and market timing from 1928 to 1932. The study examined 7500 forecasts and compared them to the actual results. To do this massive study Cowles, and other leading economists he enlisted to help him, used an IBM punch-card machine that was the height of technology in those pre-computer days. In 1933 Cowles published the results in a study called “Can Stock Market Forecasters Forecast?” His conclusion was just three words, “It is doubtful.” In 1944, Cowles published a follow up study of 6,904 market forecasts by Wall Street professionals from 1929 to 1943. This study again found “no evidence of ability to predict successfully the direction of the stock market ”.
Despite much more technology these days, the ability of Wall Street’s leading firms to forecast has not changed much. It is still doubtful. Bloomberg publishes an annual survey of equity strategists from Wall Street’s leading firms with their predictions for the upcoming year end close of the S&P 500 Index. In late December 2010 they were generally bullish calling on average for a gain of 11% in the S&P 500 Index for 2011. The most bullish was David Kostin of Goldman Sachs who said sales growth was going to spur a 17% rally in the S&P 500 Index for 2011.
We all know what happened. The S&P 500 Index for 2011 was essentially flat, with a very small loss.
Some Things Change, Some Things Don’t.