Want to know which way the market is going to jump next? Find a chatty toddler and ask her if she's feeling bullish.
No, her predictions aren't likely to be accurate. But she will probably do just as well as the highly paid forecasters you see on television.
Five dozen experts tracked by CXO Advisory Group LLC of Manassas, Va., over the past two years were right only about 48 per cent of the time in calling the broad direction of the U.S. stock market.
Mad Money's Jim Cramer saw the future with 47-per-cent accuracy, while bond king Bill Gross's public forecasts were on the money only 46 per cent of the time.
If the gurus tracked by CXO were taking a fortune-telling class, they would flunk out of soothsaying school. But their unimpressive showing demonstrates an important truth: The stock market stumps the best minds. Even the patterns that do emerge usually sucker us.
Consider emerging markets. Stock markets in developing countries handily outperformed those in the developed world from 1988 to 2009. This makes sense: The GDP growth of China and India over the past 20 years has been stunning.
So does that mean you should jump into emerging markets now? It's impossible to know. Past is rarely prologue – and the past can tell many different tales.
Slight alterations of starting and ending points can radically alter your conclusions. As I mentioned above, emerging markets outperformed developed markets from 1988 to 2009 – but they lagged behind from 1985 to 2006.
Particular styles of investing also go in and out of fashion. According to BAM Advisor Services, value stocks beat growth stocks if you look at the cumulative record for periods from 1927 to 2011, from 1979 to 2012 and from 1992 to 2012. But growth stocks have had their time in the sun as well. U.S. funds that invested in large growth stocks outperformed large-cap value funds over the 15 years ending April, 2012, according to fund tracker Morningstar.
It's small wonder that most people don't spend much time mulling these baffling patterns. Unfortunately, they do something even more dangerous: They simply jump on whatever is hot.
During the 1990s, anyone who mentioned dividend paying stocks was laughed at, derided as a relic and left in the dust by the growth investors who were loading up on dot.com stocks.
Today, with dividend-paying stocks all the rage, many investors are doing the opposite. They're abandoning growth stocks and stocking their portfolios full of utilities, consumer staples companies and other "can't miss" propositions.
They may be right, but I strongly suspect that dividend-paying stocks will, at some point, lag the market for years, simply because they've been bid up so high.
When that happens, many recent converts to the style will abandon it. That's a pity, but it's a predictable – and costly – reality of human behaviour.
The Chicago-based research firm Dalbar found that the average investor has underperformed the market, each and every year, since it began compiling data in 1990. The S&P 500 index returned an average 9.14 per cent over the past 20 years, while the average investor earned only 3.83 per cent.
The reason: Investors flock to whatever sector or style has enjoyed the biggest recent gains – with most of them arriving just as the party shuts down.
I wish I knew what would be the biggest winners of tomorrow. I don't and neither does anyone else. So I invest in a diversified portfolio of low-cost index funds. I rebalance annually. And I forget about trying to outsmart an unpredictable market.
So long as you invest in broad market indexes, you will own growth and value stocks. If you're diversified enough, you will also own both developed-world and emerging market stocks. You won't have to guess the decade's next great sector or strategy.
Best of all, you can spend your time playing with that toddler instead of asking her silly questions about the stock market.