Swedroe: ‘Gurus’ Without A Clue

In my role as director of research for The BAM Alliance, a community of more than 140 registered investment advisor firms, I’m frequently asked both by clients and other advisors to address the issues raised by market “gurus” who make forecasts in the financial media.

These forecasts often create anxiety, so investors naturally ask whether they should be worried. They also want to know what we, as their financial advisors, are doing about these risks.

Dr. Marc Faber is one such “guru.” He’s a frequent guest on CNBC, and is often quoted by the financial media. Faber’s website states that he is “an international investor known for his uncanny predictions of the stock market and futures markets around the world.” Faber is perhaps best recognized for his many prognostications of gloom and doom (he is, after all, editor of the “Gloom, Boom & Doom Report”).

With the world providing him plenty of fodder recently (the debt crisis in Greece, the Federal Reserve’s indication it will soon raise interest rates and China’s slowing economy are but a few examples), Faber is at it again. At the end of April 2015, with the S&P 500 at 2,085, Faber appeared on CNBC to warn investors that “U.S. stocks are due for a correction” of “30 percent or 40 percent minimum!”

Forecasts such as these worry investors and can lead them to abandon even well-thought-out financial plans, especially if they’re already concerned about the same issues being raised.

Faber has been forecasting gloom for the markets for a number of years, and he’s certainly earned the moniker “Dr. Doom.” The question, however, is whether investors should care what he has to say. Should they tune in when he makes a prediction? Or should they instead tune him out?

To help answer that question, we’ll go to my trusty videotape in an effort to hold Faber accountable for his prior forecasts, something the financial media rarely does because it would ruin the game.

Reviewing The Tape
In reviewing my files (I save notable forecasts, especially bearish ones, from self- or media-anointed “gurus”), I came across an interview published on Dec. 19, 2013 in which Faber makes “three very bold predictions” for 2014. Let’s see how they turned out.

1. The market will continue to decline from its November 2013 high of 1,813. The S&P 500 finished 2013 at 1,848. It ended 2014 at 2,058 (a price-only gain of about 14 percent from Dec. 19, 2013, and a price-only gain of about 11 percent for 2014). And it closed at 2,127 on July 17, 2015 (a further price-only gain of about 3 percent).
2. Facebook, Tesla, Twitter, Netflix and Veeva Systems are grossly overvalued, and the basket of shorts in these stocks will return at least 30 percent in 2014. While Faber predicted a loss of 30 percent, as the following table demonstrates, the four stocks he mentioned went on to provide an average gain of 18 percent last year.

Investors who shorted these stocks based on Faber’s recommendation would have experienced even larger losses, because the 18 percent average return figure doesn’t include transaction costs (bid/offer spreads plus the borrowing fee required to short the stock). And while Faber’s forecast was for 2014, extending the period through July 17, 2015 would have resulted in a much higher average gain and much greater investor losses.

3. The best longs for 2014 are gold, gold shares and Vietnamese stocks. The table below shows how these investments actually performed.

In short, while Faber’s best bets for 2014 managed (on average) to break even, the S&P 500 (which Faber predicted would experience a sharp drop) provided double-digit returns.

A 30 Percent Drop?
We now turn to another of Faber’s gloom and doom forecasts. On June 25, 2013, Faber predicted a 30 percent drop in the stock market. “It still has considerable downside risk everywhere,” he told CNBC. Faber’s other advice? Buy more gold.

Well, 2013 turned out to be one of the best years for the market in a long time, with the S&P 500 returning more than 32 percent. From June 25 through year-end, the S&P 500 rose from 1,588 to 1,848, a price-only return of about 16 percent. On the other hand, gold actually fell from $1,233 to $1,204, a drop of roughly 2 percent. It’s hard to have been more wrong.

Our trusty videotape provides us with another dire warning, from February 2010. Faber, along with another CNBC favorite, Jim Rogers, predicted that a full-scale global shakedown was inevitable.

They warned: “The UK Pound is on the brink of a collapse which will herald a downturn worse than 2008/9; it could well happen within weeks, and the British government is powerless to prevent it. And this in turn will foreshadow a global economic winter that could come before the end of 2010 and make the last two years seem like a mild spring day.”

Of course we are still waiting for that economic winter. And the pound, which was trading at about $1.52 at the time, never collapsed. It’s now trading a bit higher, at about $1.56.

Ritholtz Reviews Faber
Fortunately, I’m not the only one who holds forecasters accountable. Barry Ritholtz is the founder and chief investment officer of Ritholtz Wealth Management. He also writes regularly for Bloomberg View and The Washington Post. It so happens that Ritholtz spent time researching Faber’s track record for a presentation at a Financial Planning Association conference in the summer of 2014.

Ritholtz found Faber had announced in September 2009 that “stocks have likely peaked.” In 2010, Faber predicted imminent hyperinflation, saying that its occurrence was not a matter of if, but of when.

In 2011, Faber stated that the bear market had begun. Later in the same year, he predicted the value of the dollar would fall to zero. In 2012, Faber predicted a 1987-style crash sometime during the year, and he repeated the prediction in 2013 and in 2014.

It appears that Faber’s crystal ball, like all crystal balls (including mine), is actually quite cloudy. Of course, you’d never know that when you hear Faber speak, because he always appears highly confident of his forecasts.

What’s important for investors to understand is that, if someone makes enough forecasts, they will eventually get some correct. After all, even a broken clock tells the right time twice a day. Because we have a negative market return in about 30 percent of years, if market “gurus” continually forecast negative returns, about 30 percent of the time they will be right.

One (Fairly) Safe Prediction

In his presentation, Ritholtz noted that while he doesn’t believe in forecasts, he was highly confident in making the following one: “I’m going to forecast that next year Faber is going to forecast an ’87-like crash. Eventually, he’ll be right again, and people will call him a genius.”

That’s the way the financial media works. They anoint gurus so you’ll feel the need to “tune in.” Unfortunately, as highly regarded Wall Street Journal columnist Jason Zweig explained: “Pigs will fly before you’ll ever see a full list of the expert’s past forecasts, including the bloopers.”

If investors knew the evidence on forecasting accuracy (for those interested, I recommend Philip Tetlock’s “Expert Political Judgment” and William Sherden’s “The Fortune Sellers”), they would learn to tune out all market forecasters.

Here’s the advice Warren Buffett offers on the subject: “A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.”

He also has stated: “We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie (Munger) and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

Reassurance In A Scary World
Why do so many investors, most of whom idolize Buffett, ignore his sage advice and listen to the advice of forecasters such as Faber? My 40 years of experience providing financial advice to corporations and individual investors has led me to conclude that one reason investors do so is there seems to be an all-too-human need to believe that someone out there can protect them from bad things.

The field of behavioral finance provides us with a second explanation. As humans, we are subject to confirmation bias. Confirmation bias is the tendency to search for, interpret or recall information in a way that confirms our pre-existing beliefs or hypotheses.

Thus, if we are concerned about an issue and someone forecasts a future in which what concerns us comes true, we are much more likely to act on that forecast (panic and sell) than if we were not so predisposed.

Compounding the problem of confirmation bias is what is known as prospect theory. We feel the pain of losses much more than we feel the joy from an equivalent gain. That leads to what is referred to as “myopic loss aversion” (short-term thinking to avoid the pain of potential losses).

I have learned that there are only three types of market forecasters: those who don’t know where the market is going (count me among them); those who don’t know that they don’t know; and those who know that they don’t know, but get paid a lot of money to pretend they do.

Thus, my recommendation is that the next time you hear some “guru” making a forecast, no matter how intelligent it sounds, no matter how cogent the arguments made, tune it out. Do nothing.

If you’re still tempted to act, ask yourself this question: Is Warren Buffett acting on the same information/forecast? And the answer, we know, is almost certainly that he’s not. So why should you? What do you know that Buffett doesn’t? Are you smarter than Buffett?

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.