Thursday, January 2, 2014

Vaccinate Yourself Against 2014 Predictions with Silver Medals

Its prediction season! What will the market do? What will happen in economics? In the world? No one really knows but there sure are lots of people ready, willing, and able to give authoritative sounding predictions on what will happen in 2014.

I follow a simple rule of thumb - I do not read anyone's predictions unless first they also give a full accounting of how their previous year predictions panned out (usually poorly). This eliminates 90+% prediction reading.

Jason Zweig goes one further:

"The consensus already emerging on Wall Street is that U.S. stocks will have a decent year in 2014, perhaps returning 8% or 10%. That sounds plausible; since 1926, when modern data on the U.S. stock market began, stocks have averaged a gain of 10.1% annually. But in how many of those years did stocks return between 8% and 10%? In 88 years, it has never happened once. Stocks almost always perform either much better, or much worse, than investors expect them to. That's why relying on the comfort of a consensus forecast is so dangerous. As G.K. Chesterton wrote, "Wisdom should reckon on the unforeseen." So should investors."

The point here is to not get hung up on yours or anyone's ability to predict the future, this week, this month, this year. Instead position to deal with a range of possible events.

A good example of this is from Markel CIO Tom Gayner. Gayner once referred to his holding dividend paying stocks in this environment as his Silver Medal strategy. If there are two possible near term outcomes in the current situation - Inflation or Deflation.

In an Inflation scenario the likely best place to be is commodities which rise with prices, the second best is dividend stocks in companies which can raise their prices and the third (worst) is bonds which cannot keep up. Bond investors get killed in an inflationary scenario.

In a Deflation scenario the best place is bonds, the second best is dividend paying stocks and the worst is commodities.

So we do not know for sure if we get inflation like the 70s or we get deflation like Japan, in Gayner's view, the Silver Medal, second place in either case is the place to be.

So rather than predicting and handicapping a specific outcome, find steady Eddy, dividend payers that do well enough over multiple scenarios. 

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