Predictions Are Only Guesswork

 | Dec 19, 2011 | 2:30 PM EST  | Comments
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It is Christmas week, and the buzz level is picking up noticeably here at Chez Melvin, where the kids from 27 all the way down to 8 are getting excited and anticipating next weekend. The way these kids act, you would think the Orioles were in the World Series and Game 1 was next weekend. My wife has an ever-growing list of stuff to be wrapped and other stuff to be baked. There is food and wine shopping to do, which is the only task I am actually allowed to undertake this week.

I am already so sick of Rudolph, Frosty and the Christmas Hippopotamus that I am considering disconnecting the car stereo. You can tell the holidays are near by the excitement of children, the endless songs and the veritable flood of market and economic predictions for next year.

It is starting already. The weekend financial press had the first of what will be a long list of predictions for 2012. We will hear some very smart guys and gals talk confidently of 1500 on the S&P 500, while other equally smart folks will give a dire forecast of 600 for the index. Others will declare the year of retail and tell us of a rebound in consumer confidence that leads all the retailers higher in the next 12 months.

Some will suggest that Europe will find a way to settle the banking issues and move forward. Still others will predict that Europe continues to kick the can down the road with disastrous consequences for the European Union and the financial markets. According to the pundits, China will either contract or expand next year, depending which pundit's tie you prefer.

Making predictions about the new year is fun. I am going to do it before this week closes, because it's a neat intellectual exercise, and if you are right you can claim bragging rights. However, if you try to position your portfolio to take advantage of these insights into the next 12 months, this can be a form of fiscal insanity and irresponsibility. Even the most educated of guesses is exactly that, a guess. Not only can we not be sure it will happen, we have no idea how the market will react to a particular development.

Remember the first Gulf War, when everyone was sure oil would soar when the fighting started? The first shot started a huge decline in oil prices, and traders were trapped in a crowded trade with no exit. Markets routinely respond to news in the way that hurts the most prognosticators.

You can expect that Europe will continue to be volatile and that solutions and rumors of solutions will continue to issue from the Old World. The Middle East is almost certainly going to continue to see upheaval and the toppling of existing governments. After today, tensions on the Korean Peninsula will be high for much of 2012. The U.S. political situation will be a circus all the way up to Election Day. We can predict that these things will happen. But believing you have a clue what the stock market will do as a result of the news is to set yourself up to lose lots of money.

As investors, we are far better off reacting to what the market actually does rather than trying to predict what it will do on the basis what we believe might happen in the world. If there is disruption in Korea and the Middle East and markets collapse as a result, it will be time to drag out the shopping list and buy stocks at too-cheap-not-to-own prices. If China accelerates its growth rate and the markets explode, then it will be time to look through you holdings for stocks that have reached overvalued levels and should be sold. If nothing happens to create opportunity, then exercise your right to do nothing.

Most of your success in the markets each year is going to be a result of buying the right stock during the one or two times a year that the stock market is as unloved as the Red Sox in my house and selling when they are as popular as the Yankees in midtown Manhattan. Make predictions for bragging rights, but save your investing dollars to exploit market reactions to events.

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