Insights & Advice


Predicting the next stock market crash


As part of my job as a money manager, clients will often call or send me some doom and gloom report predicting the next financial meltdown. If I had a dollar for every time these author’s predictions proved accurate, I might have just enough to buy a cup of coffee. Why then, do investors take them seriously?

The short answer is simple; the desire to know the future is a deep human psychic need.  We Americans, as a country, are fairly gullible and a large number of us still believe divining the future is possible. In the case of finance, predicting the future can also mean the opportunity to gain (or lose) huge amounts of material wealth.  Authors of these reports also know that fear and greed, along with the herd instinct, are the three main emotional motivators among stock market investors.  If you couple those traits with just the right amount of sensationalism, you have a formula for an extremely effective sales pitch.

After all, the objective of these end-of-the-world reports is not to inform or educate, but to get the recipient to dip into their pocket and subscribe to an investment service, a newsletter or purchase of someone’s next book.  The formula works so well that an entire industry has grown up around the concept. Today there are thousands of newsletters promising to unlock the future for you and me. It rarely works.

The news media often refers to this person or that person who “called the financial crash” or some other past market decline, but the evidence indicates otherwise. More often than not, that mythologized  money manager or strategist may have voiced worry or concern over a specific issue—the housing market, easy lending, leveraged balance sheets—but not that the bond and stock markets would collapse as they did in 2008-2009.

In my own columns, for example, I voiced concerns back in 2007 and early 2008 that the stock markets were heading for trouble, but I never conceived of the extent of the problems or the magnitude of the declines. At most, I could and did correctly predict the short-term direction of the markets. Like everyone else, it was all I could do to keep up with the changing economic and political chaos as it unfolded.

No doubt someone got it right, but how useful is that? The laws of probability tell us that in a world where there are thousands of forecasts per day on everything from the weather to the number of new births in Bangladesh someone is bound to get a direct hit at some point.  The question is whether that same person can do it consistently. The evidence says no. A lucky forecast by an individual or group on a specific event will be normally followed by a return to mediocrity (incorrect forecasts) in almost every case.

The forecasting track records for all kinds of experts are spectacularly poor no matter what the field. Despite all the advances in science, technology and computing, experts are no better at predication than they were in the days of Delphi.   That’s largely because modern science is proving that the deterministic view of the world, where the future is determined by a given set of rules and patterns, is naive. Rather, the future is fundamentally unpredictable and governed by the theories of chaos and complexity.

So the next time you receive one of these missives of misery my advice is to dump or delete it. The next crisis, whenever it occurs, will not be determined by events from our past. These writers usually rely on subjects that have already been discounted but are guaranteed to push your buttons. Things like the defecit, the debt level, the government (or lack thereof), hyperinflation or deflation, political chaos, the Chinese, the Middle East, oil, gold and the value of the dollar usually take center stage in their litany of reasons for the next Armageddon.

Remember this, it is not what we know, but what we don’t know that will get us every time. If the writers truly know something we don’t, why in the world would they need to write us for money?







Posted in Portfolio Advice, The Retired Advisor