Swedroe: Ignore Forecasters At All Costs

December 10, 2014

The historical evidence shows us that, in the long run, a thoughtfully designed, diversified portfolio of passively managed funds typically beats the performance of all but a few active managers. And while it’s simple to structure such a portfolio, it’s not easy to maintain.

All too often, emotions—such as greed or envy in bull markets, and fear or panic in bear markets—can cause even well-developed financial plans to end up in the trash heap.

Investor discipline gets tested not only by market movements, but by the prognostications of financial “gurus” hyped by the financial media. Their goal is to keep your attention, and they make money selling air time.

There’s a lot of evidence from academic research showing there really aren’t any reliable market forecaster, and I can’t forget the admonishment of perhaps the most admired investor of all time, Warren Buffett, to ignore all forecasts because they tell you nothing about the direction of the market.

That said, I still spend a lot of my time as the director of research for the BAM Alliance having to convince investors to ignore the predictions of pundits such as Jeremy Grantham.

I should point out that I really like reading Grantham’s investment letters. I find them insightful and filled with interesting information. And I’ve also had the pleasure of hearing him speak at conferences.

Grantham Has Been Very Wrong

While I have great respect for his writings and ideas, I totally ignore his advice when it comes to trying to time the market because I believe that particular advice has no value whatsoever.

For the last several years, Grantham has been among the many gurus warning investors both about high valuations (P/E ratios) and high profit margins. Basically, the warning is that both these metrics are currently at high levels and will very likely revert to their historical means, producing either a big bad bear market or a decade of lousy returns.

Unfortunately for the investors who listened to Grantham’s sage counsel, the markets have continued to ignore him. For example, while the long-term average of the Shiller CAPE 10 has been about 16.6, it’s now been above 20 since 2010. That’s what has caused Grantham to warn about reversion to the mean.

At the start of January 2010, the Shiller CAPE 10 stood at 20.5. By the following year, it had risen to 23.0. At the start of 2012, it stood at 21.2, and climbed to 21.9 by the start of 2013 and 24.9 by the start of 2014. As I write this on Dec. 5, the Shiller CAPE 10 continues to defy Grantham’s call for reversion to the mean and stood at 27.2.

After rising 16 percent in 2012, the S&P 500 rose another 32.4 percent in 2013, and was up almost another 14 percent year-to-date. I would add that, while the Shiller CAPE 10 is at relatively high levels, the current P/E ratio doesn’t look so high.

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