Practical analysis for investment professionals
30 April 2018

Beware of Experts Bearing Forecasts

I read another article recently that warned of an impending market downturn and cited Nobel laureate Robert J. Shiller. Such pieces are ubiquitous these days and Shiller quotes and interviews often feature prominently.

Shiller is a brilliant economist and academic whose contributions to the canon are well known. His accomplishments have been truly remarkable.

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He has also been hailed as a soothsayer for correctly calling the bursting of the dot-com and housing bubbles in the 2000s. More recently, he has sounded the alarm about a potentially overvalued stock market based on the elevated reading of the CAPE ratio, a metric he invented.

But as smart and accomplished as he is, Shiller is not infallible. Nor have his forecasts been as prescient as media reports might suggest. Indeed, anyone trading on his forecasts could very well have suffered a significant opportunity cost and generated returns far below the market.

For example, Shiller’s Irrational Exuberance was published in 2000, right before the tech collapse that it anticipated occurred. But Shiller had been issuing bearish predictions for years. In July 1996, he wrote:

“[I]t is hard to come away without a feeling that the market is quite likely to decline substantially in value over the succeeding ten years; it appears that long run investors should stay out of the market for the next decade.”

Between July 1996 and July 2006, the S&P 500 rose an annualized 8.8%, just a little below the long-run average since 1926. Of course, stocks did drop precipitously starting in August 2000, but they never fell to their July 1996 levels. Thus, long-term investors who followed Shiller’s advice at the time would have lost out on significant wealth creation.

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Shiller also called the housing market crash that began in 2007. In “Is There a Bubble in the Housing Market,” published in February 2003, Shiller and co-author Karl E. Case wrote:

“[I]t is reasonable to suppose that, in the near future, price increases will stall and that prices will even decline in some cities. We have seen that people are not as confident of real estate prices as they were even before the 1980s real estate bubble burst, and this lack of confidence may translate into an amplification of any price declines . . . More declines in real home prices will probably come in cities that have been frothy, notably including some cities on both coasts of the United States, and especially those that have weakening economies. But declines in real estate prices might appear even in cities whose employment holds steady.”

Nevertheless, home prices rose an annualized 11.2% through the home market’s peak, which occurred over three years later, in July 2006, as per the S&P/Case-Shiller Home Price Index. Even in the trough of the housing market, in February 2012, prices never fell as low as they were when Shiller and Case’s paper was released.

Now Shiller is raising the alarm about the CAPE ratio, which recently reached its second-highest mark ever, behind only its dot-com peak of the late 1990s. But at least as far back as June 2015, Shiller has been issuing dire predictions about lofty stock market valuations and what they could mean for future stock market returns.

Since that time, the S&P 500 has risen over 35% through the end of March.

My point here is that as much as I respect Shiller, not even the most credible forecasters can time the market profitably with any consistency. This is true of Shiller and everyone else. No academic — not Shiller, not Nouriel Roubini — no mainstream talking head Jim Cramer type, or Wall Street strategist can do it.

Even those with compelling and credible stories, sterling professional credentials, and seemingly strong track records must be viewed with skepticism.

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Indicators like the CAPE ratio that have “worked” in the past have their value, but there is no foolproof formula to time the market or rotate among sectors or specific investments.

In fact, one study found that “expert” forecasts were accurate 47% of the time. That means we’re better off flipping a coin.

So, as you listen to the gurus and read the sensational headlines about a market that’s variously overvalued, undervalued, ready to plunge off the cliff, or blast off to new heights, remember to tune out the noise and stay invested for the long run.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Mark Armbruster, CFA

Mark Armbruster, CFA, is president of Armbruster Capital Management, Inc. (ACM), a boutique wealth management firm serving high-net-worth individual and institutional clients. ACM uses index funds, exchange-traded funds (ETFs), and other investment vehicles to build portfolios designed to reduce investment-related costs and taxes in order to maximize net returns. Previously, he worked in equity research on Wall Street, following the aerospace and defense industries at Smith Barney. Armbruster also worked in the equity strategy group for Salomon Smith Barney’s Chief Equity Strategist. He also started an investment advisory firm, where he served as chief investment officer. Armbruster has served on numerous nonprofit and for-profit corporate boards. He also consults on and provides expert testimony for investment-related legal disputes. Armbruster has been quoted on investment matters in several investment publications, including the Wall Street Journal and Investor’s Business Daily. He frequently gives talks on investment matters to professional investor groups. Armbruster has served as president of CFA Society Rochester. He holds a degree from the University of Rochester.

2 thoughts on “Beware of Experts Bearing Forecasts”

  1. Steve Greiner says:

    Nice piece Mark. Keep up the good work.

  2. Leandro says:

    I share your vision on the “timing” accuracy, but in my opinion, the point made is a little misleading because although CAPE ratio is not a perfect timing tool, it serves to put expected forward returns into perspective.

    On July 96 US 10 year Treasury yielded 6.8%. Given that studies showed that with those valuation levels, forward returns would probably be below market mean and being volatility in those months so high, one should ask: Is it worth it to continue looking for that equity risk premium or might it be more sensible to park the capital elsewhere?

    I much rather earn the 6.8% with virtually no risk for ten years than make the stock market bet in that case.

    Still… great piece. Big fan of your work Mark!

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