Let's look back at how wrong 'experts' were in their predictions

Posted: Jan 23, 2006 1:56 PM

Recently, currency strategists were in a tizzy about the dollar.

The dollar rang in the new year by recording its biggest two-day plunge against the euro in five years. The dollar continued its funk when the job figures from the federal government were released, and it fell even more on fears that the economy was about to hit its anti-lock brakes hard.

Uh, oh. The dollar might be in trouble. Or maybe not. Before anyone starts worrying about whether the dollar needs intravenous fluids, we should explore what kind of success that experts, who love making financial predictions, enjoy. A good place to start is to get reacquainted with what the soothsayers were saying at the start of 2005.

Prediction No. 1: Inflation and rising interest rates will be 2005's boogeymen. A year ago, plenty of experts worried that inflation was going to break out of its cage. If this happened, untamed inflation would wreak havoc on plenty of innocent bystanders. Fixed-income gurus fretted that rising interest rates would have the real estate sector doubled over in pain and grabbing fistfuls of ibuprofen. And with bonds expected to offer higher rates, lots of investors would ditch stocks for a less risky bond fix.

OK, so what happened? Not much. In an attempt to curb inflation, Federal Reserve Chairman Alan Greenspan had started a campaign to hike short-term rates in mid-2004, and he continued the rate hikes in 2005. By the end of last year, the central bank had bumped them up 13 times. All those rate hikes, however, made very little difference if you looked at the yields on the popular 10-year Treasuries in 2005.

These Treasuries started 2005 by offering a yield of 4.22 percent and inched up to 4.39 percent by year's end. The yield on the 10-year Treasury is commonly used to calculate mortgage rates. The danger to real estate investors never materialized. In fact, real estate funds kicked butt, with the average real estate mutual fund jumping nearly 12 percent. And that prediction of investors fleeing stocks didn't materialize either.

Predictions No. 2 and 3: Large-cap growth stocks will shine. Small cap stocks will retreat. Listening to Wall Street wise men, you'd have felt like a dolt if you didn't buy into the claim that blue chip growth stocks were going to fly in 2005. The big boys, after all, had been restlessly sitting on folding chairs at the dance since they were kneecapped in the 2000 meltdown. And 2005 was the year they were finally going to stand on their own. In contrast, little companies had enjoyed such a long run of good fortune that they would surely collapse.

So what happened? According to Ibbotson Associates, small-cap stocks beat the big boys again. For the seventh year in a row. The last time small-cap stocks dominated the large stocks for such a lengthy stretch was during a 10-year period beginning in 1974. It was a close race. Large stocks returned 4.9 percent and little guys 5.7 percent. But it would have been silly for anyone to dump small caps because of Wall Street noise.

And that brings us back to the dollar. In 2005, conventional wisdom concluded that the dollar was in so much trouble that a life raft and a year's supply of macaroni and cheese couldn't save it. The big demons threatening the dollar were going to be budget and trade deficits. But the U.S. currency ended up defying expectations. It rose 15 percent against the yen and the euro. Now who could have predicted that? Which is precisely the point.

Of course, it's not just Wall Street talking heads who use divining rods to pinpoint where the jewels can be found. Financial publications spend endless drums of ink publishing their own Ouija board results.

Today, I'm particularly interested in the predictions that Fortune magazine boldly made back in the summer of 2000 after it went hunting for stocks that would shine for a decade. That was a mighty tall order, but after copious amounts of research - perhaps the staff pulled a few all-nighters - the magazine found a golden 10 stocks, which included Morgan Stanley, Univision, Charles Schwab, Oracle, Nokia and Enron. Five years later, only one stock on the list - Genentech - would have made investors a profit and the rest were buried under a towering pile of broken expectations. The average negative return for the 10 potential winners was roughly 50 percent. I wonder if it's too late for the gullible, who clipped the article and bought the stocks, to get their subscriptions refunded?

What's remarkable about these yearly prognostications is that they not only frequently miss the bull's eye, but the entire target as well. What's puzzling is that people never lose their appetite for this hogwash.

What should you do? Don't base your investment plan on experts' educated guesses or your own hunches. Instead invest in a diversified portfolio that holds the major asset classes, no matter where the market may or may not be headed.