Market turbulence and economic uncertainty create fear and anxiety among investors. Unfortunately, many turn to advice freely dispensed by self-styled investment gurus -- who claim they can predict the direction of the markets or pick outperforming stocks. Reliance on this advice can be very harmful to your financial well-being.
One form of stock market crystal ball reading is so-called "technical analysis." This, according to its proponents, is the examination of patterns in the market to identify the current trend, and then looking for patterns that suggest whether that trend is likely to continue or change.
Sharing "a Pedestal with Alchemy"
There's compelling evidence that technical analysis is nonsense. The view of those who study the capital markets, and publish peer-reviewed papers setting forth their conclusions, was nicely summarized by Burton Malkiel of Princeton University, in his seminal book, A Random Walk Down Wall Street. Professor Malkiel concluded that "under scientific scrutiny, chart reading must share a pedestal with alchemy." The concept of using past data to predict future prices has been debunked by the efficient market hypothesis -- which holds that markets are random and efficient. It is tomorrow's news that moves stock prices and markets, not yesterday's. No technical chart can predict tomorrow's headlines.
Stock pickers fare no better, but they keep trying to convince you they have predictive power that will help you to gain outsized returns.The unstoppable Jim Cramer advises you to buy banks, industrials and metals and mining. Should you listen to him?
No Better Than Coin Flipping?
Consider this: A study of 1,446 large-cap blend mutual funds for the 10-year period ending Oct. 31, 2004, found only 35 outperformed the S&P 500 index. Do you believe any individual stock picker is better than these handsomely paid and well-credentialed mutual fund managers?
The CXO Advisory Group tracks Cramer's picks, and those of other alleged "stock picking gurus." The overall rating of the stock pickers was 48%. You could replicate these dismal results by coin-flipping or by tossing a dart at a list of stocks. Is this an intelligent way to invest and plan for retirement?
In May, 2009, CXO did an analysis of Cramer's buy and sell recommendations. It concluded his recommendations are not particularly good or unusually bad. While Cramer likes to compare his performance to the S&P 500, the reality is his stock picks are often riskier than those in that index. In a bull market, you would expect higher returns from riskier asset classes.
A study by Barron's may also give investors pause before following Cramer's latest recommendations. It found Cramer's stock picks typically underperform the market. From May to December 2008, the market lost 30%. Investors who followed Cramer's advice would have lost 35%.
"No Such Thing as Stock Picking Skill"
There's something fundamentally wrong about making stock picks and knowing that some investors will rely on them, when there is no data indicating anyone has this expertise. William Bernstein, author of The Intelligent Asset Allocator and other valuable investing books, said: "It turns out for all practical purposes, there is no such thing as stock picking skill." His views are shared by Nobel laureates Merton Miller, William Sharpe and Paul Samuelson, and backed up by hundreds of academic studies.
Yet the charade continues. The same "gurus" who recommended Lehman Brothers, Washington Mutual, Worldcom, Enron and other companies that later filed for bankruptcy continue to tout their skills as investing prognosticators, unashamed and without remorse. They have new "stocks picks" for gullible investors with short memories. They hope their purported "expertise" will convince you to read their blogs, watch their television shows or -- worst of all -- entrust your money to them. I don't mean to pick on Cramer, who is no better or worse than his stock-picking colleagues. However, it is noteworthy that he recommended Lehman Brothers on Aug. 17, 2007, together with other financial stocks. That day, it closed at $58.11. Its most recent close was around 4 cents.
It may be entertaining to read their musings and watch their antics, but it has nothing to do with intelligent investing.