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Economics Forecasting is a Parlor Game

August 23, 2010

Thus spoke Chris Davis, CEO of Davis Venture Funds, at a conference I attended in May. For many people, “economics” is synonymous with the stockmarket. The assumption seems to be that if we can predict where the economy is going, then we can predict what will happen with the stockmarket. Further, if we can predict which sectors or countries are destined for short-term success or failure, then we can translate that knowledge into successful decisions about investing.

Data about the correlation between the health of the economy and the “health” of the stockmarket, however, repeatedly shows this to be a doomed strategy for investing. The market, in fact, is a leading indicator of economic upturns and downturns. This fact is so well established that the S&P 500 index is included in the top 10 leading indicators used by economic forecasters. Again quoting Mr. Davis, “This we know. 1. The market turns before the economy. 2. The sentiment turns after the market.”

In other words, economic forecasting may be a fun parlor game for investors, but it is useless as an investing decision tool. By the time we can see the economy’s direction, the market is ahead of it. Therefore, investment strategies that depend solely upon being in a sector, country, or market right before it rises, and out of it right before it falls, have an abysmal track record of success. See Princeton professor Burton Malkiel’s A Random Walk Down Wall Street or Carnation family scion Stuart Lucas’ Wealth for a synopsis of the numerous studies done on this subject.

Successful investment strategies are as numerous and unique as individual investors themselves, yet what they all have in common is: 1) time in the market; 2) high savings rate; and 3) absence of fear and greed in decisionmaking. There is no proven formula to produce an economy that can feed, house, employ, and nurture its entire population. But, fortunately, if we stick to an investing strategy crafted just for us, we can feed, house, employ, and nurture ourselves for years to come.

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