"Predicting the Market - An Impossible Dream"

Sydney M. Williams

Thought of the Day

“Predicting the Market – An Impossible Dream?”

December 6, 2010

Extispicy is the practice of using anomalies in animal entrails to predict the future. It was used by wandering tribes in ancient Mesopotamia. Like many methods used today by those who toil in Wall Street, it was based on a vague legitimacy. In its essence, it was a form of autopsy, which might reveal internal diseases which could be tied to environmental factors, information that would have been useful to a nomadic people. Similarly, an analysis of the periodic slaughter of both bulls and bears may prove instructional to those charged with predicting markets, or at least so the witches and warlocks of Wall Street would have us believe.

Speaking of witches, Shakespeare used the three witches in Macbeth to tell the future. You might recall that Macbeth felt himself quite safe when the witches forecast: “Macbeth shall never vanquished be until/Great Birnham Wood to High Dunsinane hill/shall come against him.” Little did he suspect that Macduff’s soldiers would use branches from Birnham Wood to camouflage their approach. In another instance, Dr. Kananga (aka Mr. Big), you will recall, relied on Solitaire’s reading of the Tarot cards, in the James Bond film Live and Let Die to know what lay ahead. My wife insists that when one awakes on the first of a new month the first word one utters should be “rabbit,” as that will bring good luck for the next thirty days. Others use numerology, palm reading and interpretations of dreams as means of divination. Sherlock Holmes resorted to his violin, allowing his mind to relax and wander, permitting him to envision the past that he may bring justice in the future.

The tools we use today are somewhat more advanced, but I am skeptical that the conclusions are any more accurate. The question becomes: what good is a weatherman who tells us what was and what is, but cannot tell us what will be? On Wall Street we use the past to forecast the future; nevertheless, the same question can legitimately be asked of strategists and economists.

On Wall Street we get paid to do what no one has ever been able to do with absolute consistency – predict the future. The process is reminiscent of the eternal search for truth – the quest of E. B. White’s mouse, Stuart Little, or the search by Percival (who sat at King Arthur’s Round Table) for the Holy Grail – the chalice from which Jesus allegedly drank at the Last Supper. As you surely remember, the book, Stuart Little, ends with Stuart still in pursuit: “…the way seemed long. But the sky was bright, and he somehow felt he was headed in the right direction.” We all face forward; ergo, we make predictions.

Analysts’ opinions of the future are often driven, not just by rational analysis, but by the psychology of their makeup, the composition of their personalities – are they cynical or credulous, negative or positive? – effects their conclusions. As coldly analytical as they may perceive themselves – they assume that rational analysis, not emotions or preconceptions, lead to their conclusions – it is the humanism of the forecaster that must be considered. In our business, skepticism is generally considered imperative for an analyst. But the ability to be comfortable in one’s forecast requires a high level of self-confidence, a positive view of one’s self.

Despite arguing the case that forecasting the future is a “fool’s game’, we must acknowledge that every decision we make involves a forecast, whether it is to get married, to have children or to buy a stock. We cannot avoid the practice. At times, we may rely on analytical skills; at other times, the decision may be based on instinct. Charles Ellis, the founder of Greenwich Research Associates, in a 1974 article in the “Financial Analysts Journal” entitled The Loser’s Game used tennis as an analogy. The way to win is to limit your losers. Even so, every successful business person must have some of what President George H.W. Bush once referred to disparagingly as that “vision thing” – not just the conception of an idea, but a sense of perception based on intuitive cognition formed from experience. Successful entrepreneurs (builders) are typically optimists. Successful critics (wreckers) are more often pessimists.

Based on what we read and to whom we speak and given our unique personalities, we reach conclusions. “Know thyself,” said Socrates. Those guiding words are critical to anyone making forecasts and, as important, to the recipient of forecasts.

Having lowered the bar for expectations substantially, my predictions include: 1) continuing deleveraging in the West will keep economic growth below recent historical levels, but, despite Friday’s job report, economic conditions will gradually improve; 2) rising commodity prices will ultimately work their way through to increased food and fuel costs, impacting inflation and interest rates; 3) populations in the East – China, India and South East Asia – will gradually become richer, offering opportunities for American technology, services and manufacturers (read the piece on GE in Sunday’s New York Times); 4) after years of in-fighting, a middle way is likely to be found in Washington, following the example of the Deficit Commission and the “shadow commission” led by Alice Rivlin and Pete Domenici; 5) containment of rogue nations – Iran, Syria and North Korea – may be found utilizing cyber technologies rather than air strikes; 6) the best values today seem to lie with equities, especially larger-cap U.S. stocks selling at relatively high earnings yields, rather than with bonds or commodities, and 7) as an unapologetic optimist at heart, I am a believer that over time (ten years) an improved economy will allow deficits to decline and stock prices to move to new highs.

But, I admit that my abilities as soothsayer are no better than that ancient Mennonite who slew a calf, so he could study the contents of its stomach; thus the answer to the question in the title is a resounding “probably.”