Stock Market Predictions: 5 Reasons Why Financial Psychics are Flat Out Wrong

Every single first week of January, no matter what new year, the media starts spinning stories and stock market predictions. What’s going up? What’s coming down? What’s in Vogue (in the Wall Street Journal).

I suppose it’s kind of a basic human trait to imagine that there is an elite group of folks who are smarter than we are, and possess the uncanny ability to predict our financial future.

Yet, when we pass by the palm reader with her crystal ball, we almost never give her the time of day, or the $40 she’s asking for to tell you what she sees.

So what’s the difference?

Truth is, the only difference is that we put stock in what the financial psychics say, and not in what the palm reader psychics say. In terms of accuracy, neither of them hit the mark.

  1. Most predictions are just plain wrong simply because they predict mutually exclusive outcomes.

For example, it seems every candidate in a presidential race has had someone predict their ultimate triumph, and they can’t all win.

Every year, I read market predictions about the S&P index. Most year, experts predict its annual return to be some linear extrapolation of its current upward trend.

Some others think the S&P is oversold and predict downturns, but whether they are glass-half-full or glass-half-empty economists, whatever they usually predict is usually wrong.

  1. If it’s January, I nearly always read that stocks will go up this month because of the myth that they go up every January.

This, the psychics claim, is due to consumer optimism for the new year. Just like New Year’s Resolutions get us to the gym more regularly for a few weeks at the beginning of the year, the January Effect is said to change market behavior with all those who are finally executing on the “save more money” resolution that gets written down on broken resolution lists.

The January Effect was named, first, by Sidney Wachtel. Sidney was an investment banker looking for ways to characterize the market in 1942. Sidney noticed a trend that spanned the initial years of the S&P.

The S&P 500 officially launched in 1923, and Sidney is credited with observing a January trend from 1925-1942, where small stocks outperform the broader market for a few weeks.

The trend is, in actuality, a fool’s prediction tool.

There are lots of people trying to validate the existence of The January Effect and attribute its occurrence to bonus trends and capital gains losses that are gamed by some in December, hoping to outsmart the IRS.

But both trying to predict the stock market and hoping to outsmart the IRS seem like fools’ errands.

  1. Why and when the market goes up is something not even the richest, smartest, most talented people on the planet have been able to predict with any long term reliability.

People that claim that the market goes up due to consumer optimism (versus expectations of surprising company results, for example) are offering their guess. Needless to say, for every article making a prediction, one can find a counter-prediction.

Like New Year’s Resolution articles, the media is full of market prediction articles—because we, as human beings, really like a fresh new start.

We like that demarcating line of New Year’s Eve, where, when the confetti falls and the fireworks go off, we, too, can be grand in our pronouncements about what will be different this year from all the others.

But the market is the market, and it doesn’t go up or down by popular demand. If it did, we all would have willed 2008-9 to go a different way.

I’m not saying that authors don’t get lucky—sometimes they do. But when we’re five years from retirement and need them to be right, they almost never are.

  1. People long for security. That’s why people are receptive to predictions, especially ones that come from (often self-proclaimed) celebrities.

To feed our appetite, there are plenty of people willing to make public predictions about things that are unpredictable, and most of them are wrong.

When a prediction turns out to be right, it’s our brains that make it seem so. We’ve got a cognitive bias in the human brain called Hindsight Bias.

Hindsight Bias says that our brain sees everything in hindsight very clearly.

Our brain creates a chain of events informed by the outcome that leads to a kind of determinism.

Behavioral scientists know that when human beings look back at a chain of events determine that we see causation, we create stories about how what happened was meant to happen.

However, after-the-fact certainty leads to revisionist thinking and masks the true chaos of the world around us.

Memories of what information was available to us at the time are lost to a fatalistic attitude of “Well, it was obvious that was going to happen!”

  1. If someone could really predict the future, they would never publish their predictions.

If someone could know what was about to happen in the market with real certainty, they’d find a way to bet on their hunch, leverage their bet to the sky, wait for their outcome to occur and then cash their big fat check.

And then they’d move to paradise, right?

They wouldn’t have much to do with “chicken little”, running around to tell us the sky is falling, they’d just make their bets and quietly cash in.

Rather than be distracted by the temptations of bad financial predictions, and the lottery promise of a stock market windfall, we need to stay the course.

If this is the start of another year without a financial plan, it’s imperative that instead of making resolutions, you contact a professional, describe your dreams in detail, and figure out how to afford to make them come true.

A financial planning professional with a fee-only approach has a fiduciary duty to your dreams.

They don’t sell you products where they earn a commission, and they don’t predict the future like the psychics, but they can craft a sensible financial plan with low risk and high reward, and execute that plan with you so that your long-term dreams have funding enough to grow out of dreams and into your reality.

In the comments below, tell me about the worst stock market prediction you ever relied on…