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Home Uncategorised

Why Stock Market Predictions are Useless

by Ram Balakrishnan
April 28, 2008
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Responding to a question from a group of business students on what investors should do, Warren Buffett replied:

The answer is you don’t want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that […] if you knew what was going to happen in the economy, you still wouldn’t necessarily know what was going to happen in the stock market.

A recent article in The New York Times provides a fine illustration of the pitfalls that Mr. Buffett is warning about – you may be totally right about the economy but utterly wrong about how stock markets will react. The article notes that entering 2008, investors were confident that the US economy was bound for a recession and bet that growth will outperform value, large caps will outperform value and bought into “defensive sectors” like healthcare. Investors do seem to have got the first part right as mounting evidence points to an U.S. economy in deep trouble.

But, what happened to the stock markets? Since the beginning of this year, there is little to choose between growth and value among the S&P components. The iShares 600 Small Cap Index (IJR) has outperformed the iShares S&P 500 Index (IVV) by almost 2%. And healthcare is the second worst-performing sector with returns poorer than the much maligned financial sector.

The article concludes that this is one more reason to “ignore market chatter and simply stick with a diversified investing plan that calls for investing some money in large-cap stocks and small-cap shares, in growth and value, and in every sector of the market”.

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The man who does not read has no advantage over the man who cannot read - Mark Twain