Swedroe: Ignore Forecasts—They're Usually Wrong

I have been quite surprised by the number of queries I’ve received recently from advisors and clients regarding the dire economic and market forecasts of Frank Porter Stansberry. So, I thought I would share my response.

To begin, here’s the entry for him on Wikipedia: “Frank Porter Stansberry is an American financial publisher and author. Stansberry founded Stansberry Research (previously Stansberry & Associates Investment Research), a private publishing company based in Baltimore, Maryland, in 1999. He is the author of the monthly newsletter, Stansberry's Investment Advisory, which covers investments and investment theory in commodities, real estate, and the stock market. He is also the creator of the 2011 online video and infomercial titled ‘End of America’ (77 min). In 2002, the SEC brought a case for securities fraud and a federal judge fined him $1.5 million in 2007.”

The Wikipedia entry goes on to highlight an SEC enforcement action against Stansberry. While working for Agora Financial, another financial newsletter publishing company, Stansberry and Pirate Investor LLC were sued by the SEC for defrauding subscribers of a newsletter Stansberry wrote under the name “Jay McDaniels.”

With some extra due diligence via the web, I was able to locate the SEC’s complaint, the SEC’s litigation release and the U.S. District Court ruling for the case against Stansberry. The complaint provided that Stansberry and Pirate Investor were intentionally defrauding subscribers by falsely claiming to have the “inside track” on government deals and then charging subscribers $1,000 each for access to this “inside” information.

The email soliciting newsletter subscribers even encouraged recipients to stake their entire investment portfolios on the unnamed company for which Stansberry had inside information. Unfortunately, numerous subscribers purchased the newsletter and made investment decisions based on that purported inside information, which turned out to be false, and, as a result, did not realize the profits that the newsletter promised.

Stansberry and the other defendants in the case, however, profited handsomely. The SEC alleged that the defendants received in excess of $1 million from the sale of false information to its newsletter subscribers. The judgment order from the U.S. District Court was entered in favor of the SEC against both Pirate Investor and Frank Porter Stansberry for securities fraud. On an appeal from Stansberry and Pirate Investor, the U.S. Appeals Court affirmed the lower court’s ruling.

Stansberry Followers May Have Missed Out

Now, one would think that, before putting any credibility behind someone’s forecast, investors would do at least a minimal amount of due diligence on them. I believe just reading the Wikipedia entry on Stansberry should have been enough to end any thought about following his advice. But one could also look into some of his available forecasts.

We’ll start with Stansberry’s 2011 prediction, in his video, about the end of America. From 2011 through August 2016, the S&P 500 provided an annualized return of 12.5% and a total return of 94.9%. Investors scared off by his dire warnings missed out on those returns.

And if investors were still interested to find out about additional historical forecasts of his, they could have uncovered this June 2013 video in which Stansberry predicted a high-yield bond market crash.

In his comments, he essentially says it’s a sure thing that the high-yield bond market will crash based on the end of the ability of the government to print more money and continue to push rates down further. From June 2013 through July 2016, the Merrill Lynch High Yield Master II Index returned 3.9% per annum and a total return of 12.9%. Once again, investors who were scared off by such warnings suffered opportunity costs.

You could almost certainly create a long list of such missed forecasts. Like many, Stansberry makes many predictions, and, like a broken clock, eventually gets one right. Many people then anoint these forecasters as gurus, when it’s far more likely their getting it right was more analogous to the blind squirrel on occasion finding an acorn. But pigs will fly before you see an audited list of all of a “guru’s” predictions.

From my years of investment research, I know there continues to be a large body of evidence showing there really aren’t any good market forecasters—those giants who can protect you from bear markets by getting out ahead of them and then back in again in time to capture the rally.

In fact, despite Wall Street’s mythology, the evidence on active mutual funds is that they don’t perform any better relative to their benchmarks in bear markets than they do in bull markets (which is pretty poorly).

For example, a study in the Spring/Summer 2009 issue of Vanguard Investment Perspectives, which covered the period 1970 through 2008, defined a bear market as a loss of at least 10%. The period Vanguard studied included seven U.S. bear markets and six in Europe.

After adjusting for risk (that is, exposure to different asset classes), Vanguard concluded that “whether an active manager is operating in a bear market, a bull market that precedes or follows it, or across longer-term market cycles, the combination of cost, security selection, and market-timing proves a difficult hurdle to overcome.”

Researchers also confirmed that past success in overcoming this hurdle does not ensure future success. Vanguard reached this conclusion despite the fact that the data favored active managers because it contained survivorship bias.

He’s No Buffett

To me, the most interesting question about Stansberry and investor reaction to his forecasts is this: If investors were asked, “Who do you think is the greatest investor of our generation?” an overwhelming majority would answer, “Warren Buffett.” If they were then asked, “Should you follow the advice of the person you consider the greatest investor?”, you would think they would say, “Yes!”

The sad truth is that while Buffett is widely admired, a majority of investors not only fail to consider his advice, but tend to do exactly the opposite of what he recommends. Does any investor think Buffett is paying attention to Stansberry’s forecasts?

They certainly shouldn’t, because Buffett has said that “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” and that “forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”

Because we know Buffett is ignoring Stansberry’s advice, the question investors should be asking themselves is: What do I know that Buffett doesn’t that would cause me to heed Stansberry’s advice? The obvious answer should be “nothing.”

One Last Thing
There’s one more important point I want to make. In my more than 40 years of providing risk management counsel on markets, I’ve learned that we are all subject to both confirmation bias and cognitive dissonance.

That means when we hear ideas that confirm our beliefs and/or fears, we tend to put lots of weight on them (and are overconfident about them being correct). On the other hand, when we hear things that disagree with our beliefs/concerns, we tend to reject them, ignore them or discredit them. And that leads to big mistakes.

As one example, research shows that when the political party we favor is in power (holds the presidency), we tend to be more confident, and that leads to less trading and thus better results. We believe that if there are problems, they will get fixed. The reverse is also true. When the party we favor is out of office, we tend to become less confident and trade too much, avoid risks, and so on, and thus get poor returns.

Since 2008, the vast majority of the calls that I’ve received from investors concerned about the markets came from Republicans. And in the prior eight years, those calls mostly came from Democrats. Thus, in the last eight years, Democrats likely have been better investors and, in the prior eight years, Republicans were likely better investors.

The best recommendation I can give you is to stop reading forecasts from so-called gurus. One reason is that it’s important to understand that most of them aren’t really even in the business of forecasting. Instead, they are in the business of “fame.”

You don’t get famous by forecasting “normal” markets. You get famous by forecasting either massive bull markets, as the authors of the 1999 book, “Dow 36,000,” did (and we know how that turned out), or by forecasting dire outcomes, as Stansberry does, I believe in order to scare people.

Remember, there are lots of people out there who have something to gain by your taking action instead of your adhering to your well-thought-out plan. They tend to speak not only with great conviction, but with certainty about the future. Unfortunately, the research shows that, at best, their forecasts are about as useful as tossing a coin.

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