The Big Lie Exposed: The Future is Not Predictable

02/02/2009 05:12 am ET | Updated May 25, 2011
  • Jeff Schweitzer Scientist and former White House Senior Policy Analyst; Ph.D. in marine biology/neurophysiology

I will prove to you that everything you thought about Wall Street is wrong. Choose any famous money manager or Wall Street guru or any billionaire, and I will show you that none has ever done better than chance over time in predicting market movement. That includes David Swensen, Warren Buffet or any senior analyst at any major brokerage house. Nobody can predict the future, no matter how wealthy, smart or lucky.

Testifying before the Senate in 1967, Nobel Prize-winning economist Paul Samuelson declared: "A typical mutual fund is providing nothing for the mutual fund owner that they could not get by throwing a dart at a dartboard." He was rekindling an idea initiated 40 years earlier by Edgar Lawrence Smith, who presented in 1926 the first credible attempt to estimate the long-term return on stocks through empirical analysis. In his book Common Stocks as Long Term Investments, Smith looked at stock investments assuming no market timing or stock selection ability whatsoever; instead he used a hypothetical investor who simply held onto stocks, and found that such an investor outperformed professional bond investors. This result, to say the least, was not highly regarded. Three years after publication, in 1929, the market collapsed and Mr. Smith fell from favor. As we will see, however, people missed the point, and in fact Edgar Smith was right. What they failed to grasp was the need to hold on to stocks long-term, even in times of significant loss in the market.

Building further on Smith's idea, and Samuelson's elaboration, Burton Malkiel published in 1973 his now-famous attack on the financial establishment in a book entitled, A Random Walk Down Wall Street. This was no ordinary academic think piece. With this book, Malkiel launched a direct and aggressive challenge to the authority of Wall Street, and his work was and is still today reviled by brokers and others with a vested interest in the status quo. In his publication, Malkiel postulated that a blindfolded monkey throwing darts at a newspaper's stock tables could outperform any stock picker over time. I am that blindfolded monkey. That is OK, I have been called worse. But I am living proof that the random walk works. Over the past five years my investments have yielded an average annual rate of return of 4.3%, and that includes all of 2008. In times of plenty such a return seems paltry, even embarrassing, when others are earning 20% or 30% annually. But averaged over time, compared to everybody else during good times and bad, the number starts looking attractive. While the stock market lost nearly 50% of its peak value, I gained. I did so because I never try to predict the future. I would rather be the turtle than the hare when I cross the finish line.

The reality of random walk theory exposes the structural fraud of Wall Street. But we tend to resist the message so elegantly put forth by Malkiel because all of us so desperately want to believe that something about the future can be predicted. After all, you can "predict" that the sun will rise in the east tomorrow morning. But in fact that is not a prediction of the outcome of a statistical probability at all; it is the known result of orbital mechanics. Predicting movement in the stock market is entirely different: once you enter the market, at that precise moment you have exactly a 50.00000% chance that the stock will move up or down in price. Nothing you do beforehand, no amount of research, no amount of technical analysis, no amount of wishing upon a star will change that simple fact. But there remains one more important element: when you exit the stock market, you have exactly and precisely a 50.00000% chance that the market will move up or down from that moment forward. Any effort to change that rule of nature, to nudge that 50% mark off center, is completely and hopelessly futile. Try and you will fail. Once you enter the market, you can only know one thing: with time the market will go up or go down. Any statement or claim beyond that is witchcraft, and you can never predict which of the two will prevail for any one stock.

Gurus pretend they can nudge away from that immutable 50% reality, but they are wrong. Absolutely, deeply, inherently wrong. But they keep serving up the nonsense. Here is a direct quote, a sample of the usual claptrap that passes for investment prognostication, from a highly reputable brokerage house, published in late 2007:

Wall Street Gurus Say No Recession in 2008

As a new year begins recession fears are looming, but Wall Street gurus remain optimistic about 2008. Despite the subprime credit crisis that contributed to a volatile second half of 2007, the U.S. Economy will beat the odds of a recession, re-accelerate over the course of 2008 and help to stabilize most financial markets, according to Mesirow Financial's fourth annual Investment Outlook. A separate UCLA Anderson forecast suggests that despite rising oil prices, sinking housing prices and a turbulent stock market, the nation will escape a recession in 2008.

Here is a quote from the Herald Tribune on December 25, 2007:

"Some economists predict that the U.S. economy will slide into recession next year. Others expect the nation to avoid recession, if only barely. A few even think the economy will see solid growth."

Need I point out how silly and useless that is? These ridiculous pontifications are typical of the drivel from Wall Street passing as wisdom. As with these pathetic attempts to divine future market movement, all investment strategies are doomed to fail over time because all share the fundamentally flawed notion that the future is predictable. Nothing could be more ludicrous or futile. The future is deterministic, but unpredictable, just like any chaotic system. We will simply never know enough about all variables to make truly useful predictions that will stand the test of time. What passes now for strategy, research, investment systems and wealth-building methods are nothing better than reading tea leaves or the pattern of scattered bones. If you doubt this truth, find me one analyst, one money manager, one investment guru who five years ago predicted the economic implosion of 2008, or that stocks would decline by nearly half of their peak value.

Equally maddening are "expert" explanations ex post facto of why the market moved in a particular direction. Let's say new unemployment figures are to come out, and are widely expected to push the market down. But instead the market reacts by going up. The self-proclaimed "analysts" will say, with no hint of irony or embarrassment, "The market had already anticipated the bad news." But if in fact the market had gone down, those same experts would claim brilliant predictive powers, and conclude that bad employment news "caused" the market loss. No matter what happens, these charlatans can create any explanation they want to fit the know facts. The analysis is truly useless.

The utter futility of trying to foresee the future has not stopped traders and brokers from creating ever more sophisticated methods that rely on predicting market movement. The urge is too great to resist. So this tragic flaw, this inability to recognize that the future will never be predictable, is often masked by confusing terminology and complicated math to create a comforting image of some higher knowledge. But no matter how clever the system or elaborate the math, or charismatic the money manager, the future simply can not be foretold. How can you predict market movement when you are unaware of trillions of dollars of credit default swaps hidden off-book? How can you anticipate future pricing when you do not know if the Chinese will invest $2 trillion to shore up their own faltering economy in a desperate attempt to prevent political unrest, versus investing those funds in U.S. Treasuries? And those are just two unknowns out of thousands.

If you evaluate the validity of an idea by who subscribes to the concept rather than on the merits of the argument, allow me to invoke Warren Buffet. He said, "Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years." Yes, Buffet is supposed to be the poster boy for technical traders using past performance to predict future movement. But that is just another myth. Both he and George Soros repeatedly emphasize that making predictions about the market or the economy has absolutely nothing to do with their success. If you doubt me, allow me to quote further from Mr. Buffett:

"I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years."

"If past history was all there was to the game, the richest people would be librarians."

"Our favorite holding period is forever."

That last quote is pure random walk. As with the bible, others can find competing quotes. But his sentiments here are perfectly clear. Making predictions about the future is a loser's game.

If you have had enough of Wall Street's corruption, are tired of imploding markets, and can stomach no more the talking heads spewing nonsense about market movement, then go find a copy of Burton Malkiel's book. Everything you need to know is contained within. You cannot predict the future, and any and every attempt to so will fail. That is a fundamental truth, and nothing you do will ever change that fact. The future is unpredictable. That is a fact of nature, an immutable reality that cannot be altered. Wall Street fraudulently says otherwise. They are deeply, purely, absolutely wrong. Confidence in the market can never be fully restored until this truth is openly acknowledged. We are otherwise living a lie, and that is no foundation for a prosperous future.