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Principle 1: Ignore ‘The Market’ and ‘Market Gurus’
Market experts and commentators are, for better or worse, human beings; homo sapiens, since time immemorial, has attempted to prophesy the future; and since the beginning of recorded history, confidence about the ability to predict the future has, putting it mildly, greatly exceeded their actual ability to do so. The inability to prophesy the level and direction of financial markets and securities with any reasonable degree of accuracy is an instance of a more general phenomenon: people’s basic inability to foresee the future. Mr Graham recognised this human frailty and was therefore under no illusion about the results of market-timers. | |||
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“The
farther one gets away from Wall Street, the more skepticism one will find about
the pretensions of stock-market forecasting or timing.” Indeed, “in
our [Graham and Dodd, Security Analysis: Principles and Technique] experience
and observation, extending over 50 years, we have not known a single person who
has consistently or lastingly made money by ‘following the market.’
We do not hesitate to declare that this approach is as fallacious as it is popular.”
Mr Buffett adds that “forecasts may tell you a great deal about the forecaster;
[but] they tell you nothing about the future.”
In The Intelligent Investor, Graham also noted that “aside from forecasting the movement of the general market, much effort and ability are directed in Wall Street toward selecting stocks or industrial groups that in matter of price will ‘do better’ than the rest over a fairly short period in the future.” He concluded that “we do not believe [this endeavour] is suited to the needs and temperament of the true investor. As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years.” Further, “if as we suggest the average market level of most ‘growth stocks’ is too high to provide an adequate margin of safety for the buyer, then a simple technique of diversified buying in this field may not work out satisfactorily.” A comprehensive study published in the Hulbert Financial Digest in January 1994, and cited by William Sherden in The Fortune Sellers: The Big Business of Buying and Selling Predictions, corroborates these views. HFD found that, of the 108 market timing and economic forecasting newsletters which were analysed during the preceding five years, the predictions of only two corresponded even crudely to subsequent events. This number is astonishingly smaller than would be expected by pure chance. It demonstrates that although ‘market experts’ cannot systematically get things right they can and do systematically get things wrong. Market timers, in other words, are seldom in doubt but virtually always in error. It is noteworthy that Warren Buffett and Peter Lynch, two of the most successful investors of the last four decades, disclaim any ability to predict financial markets’ level or direction. In Lynch’s words, market timers “can’t predict markets with any useful consistency, any more than gizzard squeezers could tell the Roman Emperors when the Huns would attack.” A justification from first principles of the folly of market timing is set out in a circular to shareholders entitled Why Speculation Inevitably Ends in Tears. 
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