The Only Market Forecast Worth Standing By

Irving Fisher, one of America’s most celebrated economists, famously, and disastrously, stated that stocks had reached a “permanently high plateau.” He had the unfortunate timing of doing this right before the economic collapse of the great depression. For all the good that he has done, Fisher is often remembered for this blunder.

It’s been intriguing to me as I’ve observed some very smart people follow in Fisher’s footsteps. Perhaps financial advisors and the companies that they work for feel that clients expect us to have some sort of opinion on the direction of the market. Part of it, I think stems from the idea that many clients believe they are paying their financial advisor so that they will somehow “beat the market.” This hope often isn’t realized.

From studying and thinking hard on this subject, I’ve come to the conclusion that there is only one truly honest statement regarding forecasting the market that is actually worth standing by:

“I don’t know what will happen next.”

Market fluctuations are impossible to predict in the short run

As Irving Fisher’s comment suggests, even the brightest minds can be way way off. Burton Malkiel in his book, A Random Walk Down Wall Street characterizes the short term variation in pricing of securities as (you guessed it), a “random walk.” What does this actually mean? It means that the market appears to move randomly without any particular pattern or inefficiency that we can chart out or capture in order to thereby “beat the market.” The inability to predict the short term movements and fluctuations of the market support the prevailing superiority of “passive” index fund investing over active management. In other words, the research suggests, at least so far, that you’re better off trying to capture the entire market (and not actually beat it) through the purchase of broadly diversified index funds, than pay the extra costs to fund managers who try to find the stocks that are going to outperform the rest.

The Efficient Market Hypothesis

If you’re new to investing, or come from the school of active management, all of this might feel a little strange. And it begs the question, “Well, why can’t a good fund manager or my financial advisor beat the market in any given year?” The answer to that question is that a fund manager or your financial advisor may, in fact, beat the market in any given year. It’s not the single year play that we’re thinking about though. It’s the long term statistical probability of any individual or company beating the market consistently. There will be some that do it. The trouble is this: Was it luck or skill? So far, it appears that most of the time it has been luck. And if there are those that skillfully beat the market, there isn’t a reliable way to determine who they will be beforehand.

Eugene Fama, the American economist and recipient of the Nobel Prize in Economic Sciences, is the father of the Efficient Market Hypothesis. In simple terms, the efficient market hypothesis is a theory that the market responds to new information quickly and efficiently, thereby making it impossible (or at least very difficult) to find inefficiencies to exploit and thereby “beat the market.” There are varying levels of agreement with this theory, and it’s actually quite controversial in modern finance.

That being said, I’m a believer in this theory. As such, I believe that it is so difficult as to be practically impossible to beat the market on a consistent basis. In many ways it’s a waste of time. I don’t know which direction the market is going to go in the short run, and neither do you nor anyone else.

What should you do about it?

If market fluctuations are impossible to predict in the short run with any real accuracy, what should you do about it? I have a few thoughts:

  1. When you invest “in the market,” remember that you are investing in actual companies. It’s possible, and even likely, that some of those companies will fail for one reason or another. If you have too much of your investment holdings in that company, it’s going to hurt. The flip side of this is that if you spread out your investment holdings over enough companies, one bad apple won’t ruin the whole bunch.

  2. Invest for the long haul. Hopefully you’ve noted that I’ve continuously argued against the ability of anyone accurately predicting market movement in the short run. Personally, I believe in long term growth over time. This belief is grounded in historical precedence, but make no mistake about it, historical precedence should not be taken as a guarantee for future returns. I could be wrong, after all. But if I am, we probably have bigger problems to worry about than investment portfolio performance.

  3. Invest in globally diversified index mutual funds and ETFs. Yes, invest passively. If you agree with me that short term market fluctuations can’t be predicted, then you see that it’s not very helpful to spend time trying to find the next “hot” stock.

  4. Focus on what you can control. Because we can’t very well predict where the market is going to move in the short run, we ought to focus on things that we have greater influence and control over. I encourage you to focus on keeping your investment costs and taxes low. Again, index funds can be very helpful here. You might be surprised to find that with active management you’re spending .75% of your portfolio every year just so that fund managers can time the market and guess (“select”) which stocks will outperform others. In contrast, I’ve seen index fund expense ratios as low as .04%. That’s a big difference, and a hurdle that the fund manager who charges .75% a year has to overcome from the beginning.

Some Final Thoughts

Perhaps this article comes as a surprise to you. Perhaps it doesn’t. The truth of the matter is that no one really knows what is going to happen in the short run, and in the long run, we are hoping for the best. As I mentioned previously, I think we’ll see positive returns over a long term time horizon. There are a lot of other things that financial professionals can help you with such as making sure that your investments match your risk tolerance, helping you select cost and tax efficient funds to invest in, and helping you design a strategy in retirement to live off of the wealth that you accumulate over time.

But the next time that you hear your advisor, a media commentator, or some other expert, start to expound on their opinions about the direction of the market. Plug your ears and imagine them saying, “I don’t know what’s going to happen next” over and over and over again.


These are my opinions, unless I’ve specifically cited other material. The information and ideas I’ve presented are for information purposes only. Before you implement anything, make sure you have a thorough discussion with a qualified professional who understands your situation.

Donovan Sanchez