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So, Where Do You Think Markets Are Heading?

For it is in the essence of [The long term investor's] behavior that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputations to fail conventionally than succeed unconventionally."
-- John Maynard Keynes

During a coffee break at a conference in Dubai a couple of weeks ago a fellow attendee asked me where I thought markets were headed this year. This is probably one of the most frequently asked questions in our profession. I also think it is the wrong kind of question to ask! There is always a temptation to reply with a non-committal, vague, and perfectly hedged forecast, and most people succumb to this temptation, especially on TV. Remarkably, that's the type of response expected, so when I reply with my usual "I don't know," people are shocked. I have never been kicked out of a potential investor's office because of this response, but it is reasonable to assume it has been a turnoff for many.

There are two reasons why this is not the right question to ask--or try to answer. First, trying to forecast the whole market is not only futile but can even be a dangerous distraction. Unless you are following a passive indexing strategy, no one will hold a gun to your head and force you to buy the whole market or any specific index. As an investor you will end up buying (or selling) individual securities. In the world of equities where I "hunt", John Templeton has taught us is to always focus on the value of the businesses we buy and not to worry about market trends. Your long-term return will be a function of the performance of the underlying businesses and the prices at which you buy and sell, not on where the S&P has gone over your holding period.

The other reason this question is wrong is the time horizon. No one can consistently forecast the movement of a single stock, let alone the whole market, over such a short period of time of one year. It is far easier, safer, and profitable to focus on coming up with a conservative multi-year forecast of an individual business and then buy its stock when it is trading at a significant discount to its intrinsic value. In the short-term, many economic and non-economic factors like investor psychology and the latest economic numbers drive stock prices, but over time fundamentals eventually catch up. It may take several years to happen, but eventually the market always recognizes the real value. "In the short run, the market is a voting machine but in the long run it is a weighing machine" (Benjamin Graham).

So why do smart professional investors continually try to forecast the market over the next month or quarter? I think there are many reasons, but one big reason is that it is a lot more exciting than the alternative I just described. As Christopher Browne says "value stocks are about as exciting as watching grass grow. But have you ever noticed just how much your grass grows in a week?" Studies show that the average holding period has declined over the past several decades. The average holding period for NYSE stocks has declined from more than ten years in the 1940s, to four years in the late 1970s, and is now below one year. The picture is similar for stocks listed on the LSE with the average holding period declining from around eight years in 1966 to three years in the late 1970s and below one year over the past decade. Of course the media and Wall Street have a strong interest in continuing this short-term focus, even if it is not in the investors' interest; it makes for higher TV ratings and fatter brokerage profits. Another reason professionals continue to play this short term game is that Wall Street and academia have developed so many "powerful" quantitative tools and they feel they need to use them. In Warren Buffett's words, "Value investing is so simple that it makes people reluctant to teach it. If you've gone and gotten a PhD and spent several years learning tough mathematics, to have to come back to this is like studying for the priesthood and then finding out that the Ten Commandments were all you needed." In business, only a handful of variables are important in the long term. The job of the intelligent investor is to try to focus on what matters and ignore the noise.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.