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Following the Experts is Confusing

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No wonder investing is confusing for the average investor.

Many investors take a “follow the pros” strategy. Whether that means watching the business networks, tracking Warren Buffett, or subscribing in to investment newsletters, these investors invest based on what “experts” tout.

Often though the advice of one professional runs contrary to the next. What to do?

I saw a good example of this in Yahoo News. 

These two articles were within 3 stories of each other yesterday evening.

Dow May Soar

“Dow 36,000 Is Attainable Again” [4], claims two experts.

Considering the Dow 30 closed March 7, 2013 at 14,329, that means I am looking at a potential gain of 151%. Excuse me while I sell all my holdings and plunge my cash into the Dow.

Stock Rally Will End Badly This Year: Marc Faber

What the …? I thought we were heading for good times.

Now Marc Faber is telling me that:

the stock market’s run will result in either a 20 percent correction or a more nasty sell off at some point this year

Guess I will be buying puts on the Dow rather than going long.

Who to believe? What should I do?

Who to Believe?

I have my thoughts, but who really knows.

Hassett and Glassman

I will note that¬†Messrs Hassett and Glassman first predicted this in 1999. They use the word “forecast”, but I would say prediction. Especially as it has not come pass to pass in the last 13 years. And they do not offer any firm timeline for reaching that point.

I forecast that a deadly meteor will hit earth. But I will not “forecast” when. Not a forecast gents. A prediction.

I will also note that the Dow 30 first hit 10,000 in March, 1999 [5]. If you go to the link, it mentions Ralph Acampora. He is a technical analyst and one of the first major analysts to predict the Dow would hit 10,000. Interestingly, I was at a CFA luncheon in the Cayman Islands on the exact day that the Dow first hit 10,000 and Mr. Acampora was the keynote speaker. He was quite giddy that day.

Anyway, the Dow reached 10,000 in March, 1999. Going to 36,000 may seem like a ton. But to reach 36,000 in the 14 years since 1999 would only require an annual return of 9.58%. In theory, very doable for equity investments.

Today the Dow is at 14,329. At 9.58% annual return, the Dow would reach 36,000 in 10 years. At just under 5% per annum, you would need 19 years to hit 36,000. So if you are 25 years of age, invest in the Dow 30, earn 5% annually in capital appreciation (excludes dividend income), when you retire in at age 65, the Dow should be at 102,000.

Simply based on compound growth, the Dow should reach 36,000 at some point in the next decade or two. It is not that wacky a prediction. I mean forecast.

Doctor Doom

I like Marc Faber. Swiss, looks a bit like a garden gnome and a lot like the stereotypical Swiss banker. Smart guy.

But you need to remember that his nickname is Doctor Doom. And that his financial newsletter is titled, “The Gloom Boom & Doom Report” [6]. His business is pessimism.

That said, economic and financial data do indicate a strong probability for corrections in the financial markets. Whether any correction is 20% is hard to know. Personally, I could see a 8-10% correction this year. But once the market smells blood, it creates additional momentum that could further reduce valuations.

Both Could Be Right

Hassett and Glassman are optimists and Faber a pessimist. Seems like they are on opposite sides of the argument. But both could be right (or wrong).

The long-term trend for equities should be upwards. The question is at what annual rate.

However, there will be bumps along the way.

Consider the Dow 30 chart below. Perhaps hard to read, but it shows the growth of the Dow from 1900 to February, 2013. From 68 in 1900 to 14,500 in early 2013.

Over the long run, valuations have increased significantly, reflecting Hassett and Glassman’s view. But along the journey there have been some big adjustments. Faber believes there is a strong chance that one such correction will occur soon.

What to Do?

This is why I like dollar cost averaging [7] and periodically rebalancing one’s portfolio [8] back to target asset allocations. Both techniques provide some protection against market movements.

With dollar cost averaging, when markets are high (or over-valued), you buy less. When they fall, you buy more.

With periodic rebalancing, when equities run too high, you reallocate back to the target allocation, thereby taking some gains. When valuations decrease, you shift a portion of capital from other asset classes into under-valued equities.

Works well. Give it a try.

djia1900s [9]