What Can We Learn From Unfortunate Market Predictions?

The late Murray Walker once said that he did not make mistakes, but instead would make prophecies that immediately would be proven incorrect.

Whilst he was referring to his somewhat unfortunate tendency to predict success for racing drivers who would almost immediately crash, his words could just as easily be about the difficulties in predicting how financial markets will move.

Financial markets are inherently volatile; the constant motion of the markets is how people make money from them. Whilst there are a lot of fundamental factors that shape a stock price, there are also many aspects that cannot be easily predicted.

The key to success for a prop trading agency and its staff of funded traders is to diversify, understand and manage your levels of risk as much as possible, and stick to the principles of your trading plan whilst considering the long game.

Typically it is best to trust your analysis and avoid being swayed by fear, greed and the advice of public figures making financial predictions because a fundamental principle of probability is that regardless of likelihood, there is always a chance it can turn out to be wrong.

However, even the worst, most unfortunate financial predictions can teach traders important lessons if you explore why the prediction was made in the first place.

Here are some of the most unfortunate forecasts in the history of the stock market, and what we can learn from them.

The First Celebrity Economic Blunder

Debt and loan concept
Debt and loan concept

One of the first people to help popularise and engage people outside of the financial world with the stock market was Irving Fisher, creator of the theory of debt-deflation and credit bubbles that saw a revival in interest in the late 2000s.

He is, however, an exceptionally controversial figure and a major reason why his theories took nearly a century to be taken seriously is because he was one of the earliest big-name economists to make a famously awful prediction.

On 16th October 1929, Mr Fisher stated that stock prices had reached a “permanently high plateau” and rubbished claims of a potential significant reduction bearish. He even went as far as to say that the stock market would rise higher than this point in the first months of 1930.

Eight days later, Black Thursday happened, which was the first part of the Wall Street Crash of 1929 and the start of the Great Depression.

If people listened to his predictions and waited for a higher peak, they would almost inevitably lose most if not all of their portfolio.

Whilst debt deflation is a credible theory now, Mr Fisher’s career was completely ruined by the crash, as well as assuring investors that a bounce-back was just around the corner in the months immediately after the crash.

He also lost his house and his entire wealth due to his bullish belief.

Ultimately, Irving Fisher was not as wrong on principle as it so easily appeared. Manufacturing efficiency created growth in the manufacturing sector, so with that, he saw strong fundamentals in the market.

It should also be noted that Mr Fisher’s contemporary, John Maynard Keynes, predicted in 1927 that the stock market would never crash again in their lifetimes. However, he not only preserved most of his reputation but Keynesian economics would dominate discourse for half a century.

Unfortunately, Mr Fisher highlighted that fundamentals are far from the only part of determining market prices, as market psychology is exceptionally powerful during particularly volatile times for the market.

 

Bad Wording Or Mad Prediction?

Business economy growth prediction graph
Business economy growth prediction graph

If Irving Fisher was one of the first celebrity economists, Jim Cramer is almost certainly the most controversial.

The host of Mad Money has such a huge reputation for making big predictions only for them to go awry that an “Inverse Cramer” exchange-traded fund was established that explicitly bet against his stock picks.

In 2012 alone, three of his biggest stocks to sell (Hewlett Packard, Netflix and Best Buy) were up over 100 per cent within six months of his enthusiastic call to sell, with the troubles he predicted ultimately not materialising

He was also completely wrong about Silicon Valley Bank, suggesting people buy into the popular investment bank a month before it suddenly collapsed, a prediction he blames on the regulators getting it wrong.

However, the most infamous bad prediction he ever made and one that led to a public feud with comedian Jon Stewart was his call on the bank Bear Stearns.

The historic bank had a lot of exposure to mortgage-backed securities, the main financial instrument that was credited with causing the Great Recession.

In the days leading to the collapse, Jim Cramer was bullish on Bear Stearns, and whilst the most commonly cited clip was taken out of context (he was responding to a question from someone who had funds in Bear Stearns), he did also suggest buying Bear stock as $69 per share, two weeks before it plummeted to $2 per share.

The lesson to be learned here is the importance of due diligence, especially when making particularly enthusiastic predictions.

It also highlights the power of loss aversion; Jim Cramer is exceptionally wealthy and successful and has gotten more predictions correct overall than ones he has gotten wrong. People tend to only remember the bad calls, however.

Finally, it shows the importance of being absolutely clear when providing any form of financial advice, even if it takes the form of punditry that traders should be wary of following.

 

Predicting A Fall Before A Rise

Predicting whether a new industry or a new company in a budding industry sector will be successful is amongst the most difficult predictions to make on the stock market, and most traders would be wise to avoid devoting too much of their portfolio to inherently risky investments.

Amazingly, when it comes to the future, it is possible to be both correct and so very wrong at the same time, and nowhere is that more evident than in the absurdly bold claim Nobel Prize winner Paul Krugman made about the internet in June 1998.

He predicted that Metcalfe’s law, that the potential number of connections in a network is the number of participants squared would lead to a drastic slowing of the internet, going so far as to claim that the impact of the internet on the stock market will be the same or lower than the invention of the fax machine.

That this prediction was even at one point potentially correct was surprising. Arguably, Mr Krugman predicted the dotcom bubble bursting before it had reached close to its peak in 2000, but at the same time, it was also so clearly and obviously incorrect given the value of internet-based companies now.

The internet completely and fundamentally transformed the world and by extension transformed the financial markets, and so this prediction is roundly mocked.

However, whilst it is clear that Paul Krugman wrote this sentiment both in 1996 for the New York Times and in 1998 for Red Herring magazine, some important context is missing.

The New York Times article was a futurist prediction framed as being from the year 2098, with all of the provocative rhetoric a piece that borders on science fiction can muster. It was meant to be almost satirical.

The Red Herring article was an exploration of the same concept, highlighting that so many future market predictions are wrong because they overemphasise the importance of new technology, something that was seen before the internet with predictions about robots and after the internet with technologies like the blockchain.

Interestingly, Paul Krugman predicted the cryptocurrency bubble in 2021 would burst and whilst critics would respond with his infamous fax machine claims, he turned out to be completely correct.

Context is key with a prediction, and before following (or mocking) a financial prediction, it is important to understand where the sentiment came from

Betting On The Biggest Bubble

bitcoin coin cryptocurrency bubble concept
bitcoin coin cryptocurrency bubble concept

When investing in industries that are rapidly growing, the temptation is to bet on the biggest horse in the race, but as the rather infamous story of AOL proves, the fortunes of new technology can change exceptionally quickly.

The ubiquity of America Online in the late 1990s was palpable, and at the edge of the millennium, SmartMoney magazine named it as a sure pick, given that it was one of the most visible dot-com companies during the peak of the dot-com bubble.

This seemed to be justified within ten days of the new millennium when the landmark merger between AOL and Time Warner was announced, which would be the single biggest ever completed.

It would also turn out to be one of the most disastrous mergers in history when it was completed in 2001, as whilst AOL was a much faster-growing and evolving company than the older Time Warner conglomerate, a lack of cooperation hampered the potential strategic benefits.

As well as this, AOL completely missed the rise of broadband internet, and AOL Time Warner reported a loss of $99bn in 2002, which was the single largest loss ever at the time.

By this point, the damage from the dotcom bubble bursting was already evident, and whilst it pivoted to digital media and survived, it was far from the certainty SmartMoney and others predicted in 1999.

The best choice is not always the biggest, and it is important to check the fundamentals of a company, even one that looks on the surface to be a safe bet, before investing.

Share with friends: