iOS app Android app More

Featuring fresh takes and real-time analysis from HuffPost's signature lineup of contributors
Dan Solin

GET UPDATES FROM Dan Solin

Coping With The Bogeyman Of A Market Crash

Posted: 06/14/11 08:04 PM ET

Correction: In my blog, I referred -- and hyperlinked -- to an article in Forbes, which referenced a commentary by PIMCO CEO Mohamed El-Erian about Meredith Whitney. The author of the Forbes article has now published a correction and apology to Mr. El-Erian and indicated that the commentary was not written by Mr. El-Erian and does not reflect his views. You can find the apology and correction here. I relied on the accuracy of the Forbes blog. Since it was inaccurate, the references to Mr. El-Erian in my blog should be considered withdrawn. I regret the error, which was beyond my control.

In December, 2010, Meredith Whitney, a highly respected banking analyst, went on 60 Minutes and predicted massive defaults in the municipal bond markets. Investors took note. The outflow from municipal bonds totaled $49 billion.

Investors who ignored the dire predictions of Ms. Whitney fared well. Municipal bonds have outperformed the broad market year-to-date. According to Stephen Weiss of Short Hills Capital, "Local governments are actually in better shape because of higher tax income and lower costs this year."

Undeterred, Ms. Whitney recently proclaimed: "I know I'm right."

Mohamed El-Erian doesn't think so. Mr. El-Erian ought to know. He is the CEO of PIMCO, which is one of the largest bond investors in the world. PIMCO manages over $1.2 trillion in assets. According to Mr. El-Erian, the "top down" approach used by Ms. Whitney in her analysis is fundamentally wrong.

On the stock side, things are no better. The Dow dropped below 12,000 for the first time since March, extending the longest weekly losing streak since 2002. How fortunate investors are to have the benefit of the views of financial pros to guide them through this crisis. James Altucher, who pretends to be able to predict the future of the market, has gazed into his crystal ball and tells the unwashed masses that the Dow will not only recover, but is destined to hit 20,000. He provides 10 reasons to support his prediction.

Stock market newsletter editors see things quite differently. According to one report, bullish sentiment has fallen to 40.9%, which is the lowest since the market rally began in September.

Should investors pay heed to Ms. Whitney or Mr. El-Erian? To Mr. Altucher or to editors of stock market newsletters?

The answer is simple: Ignore them all.

There is no evidence anyone has the ability to predict the future of the markets. There is significant data to the contrary. One study looked at 15,000 predictions by 237 market timing newsletters over a 12.5 year period. 94.5% of the newsletters studied went out of business. The average length of operations was only four years. The authors of the study found no evidence the newsletters were able to time the market.

If Mr. Altucher and other bulls turn out to be right, they will tout their skill. If the bearish editors of newsletters correctly call a falling market, they will do the same. Both will be mistaken. They confuse luck with skill. Skill has persistence. Luck doesn't.

There is a better way. If you have less than five years before you will need 20% or more the money you are investing, you should have no exposure to the stock market. If you have a longer time horizon, you should determine your asset allocation by taking an asset allocation questionnaire, so that your stock market exposure will permit you to hold (and not panic) during periods of short term volatility. Limit your investments to a globally diversified portfolio of low management fee, stock and bond index funds, passively managed funds or exchange traded funds.

Listening to "financial astrologers" causes investors to jump in and out of the markets, usually at the wrong times. It's great for the securities industry. More fees, more readers, more viewers and more advertising revenues, as they all try to make sense out of events that are random and unpredictable. It's terrible for investors, most of whom would be better off if they never invested.

The next time you read or view the market timing predictions of one of the endless stream of ego driven "experts," remember this quote from Investments, Fifth Edition, a leading investment text book used at the nation's top 30 business schools: "Statistical research has shown that, to a close approximation, stock prices seem to follow a random walk with no discernible predictable patterns that investors can exploit."

What is being "exploited" are investors whose savings are being decimated by the false prophets of Wall Street.

The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.

 
 
 

Follow Dan Solin on Twitter: www.twitter.com/DanSolin