The Taylor Frigon Advisor: "Stock Market Guessing"

Today, the American Institute for Economic Research published a Research Report entitled "A Persistent Delusion," which contained selected quotations from an earlier bulletin that the AIER had published in 1962.

The AIER was founded during the depths of the Great Depression in 1933 by Colonel E. C. Harwood (1900 - 1980), a graduate of the West Point Class of 1920 (pictured above).

In September 1962 he published an address given by Professor Henry W. Dunn of the Harvard Business School, with a preface declaring that "The principles emphasized in Professor Dunn's address are as important to an investor's education and to the public welfare today as they were when it was delivered." The entire 1962 address, along with Colonel Harwood's preface, can be found on the internet in the AIER archive for 1960 - 1970, under the title "A Persistent Delusion."

Speaking just ten years after the Stock Market Crash of 1929, Professor Dunn wanted to combat "what I have chosen to call the persistent delusion: that coming moves of the stock market can be successfully guessed, bringing greater rewards to those relying on that procedure than are obtainable through the adoption of any other policy."

He called this delusion an "intoxication," and indicted as a culprit the financial services industry which "finds the source of its intoxication and the chief support of its activities in never ceasing efforts to predict, by one means or another, the direction and timing of the next intermediate movement." Astonishing as it may seem, this intoxication is every bit as widespread today as it was seventy years ago -- perhaps even more widespread, as it is now reinforced by the twenty-four hour financial news cycle on television and the computer, whereas in 1939 it had to make do with printed financial publications that could only be published generally once a day.

A brief examination of any of the major financial media channels will reveal a parade of guests being asked about their opinion of the next move in oil, or in the dollar, or in the financial sector, or in the central bank's interest rates, and the best stocks or other investment instruments to buy in order to profit from the predicted move.

Professor Dunn categorized all such behavior under the excellent phrase "stock market guessing." He noted that believers in stock market guessing did not necessarily believe that it could be done "with 100 per cent of accuracy, but enough of the time, and with a high enough percentage of accuracy, to make buying and selling stocks on such judgments the most profitable way to employ money."

We would agree completely with Professor Dunn's observations, and with E. C. Harwood's 1962 remarks that the passage of decades has done nothing to diminish the importance of combatting this "persistent delusion." In fact, just as Professor Dunn observed, we have said that the financial industry has fostered this very delusion, and that "financial advisors" like to wrap themselves in a cloak of superior knowledge about upcoming cycles, and that it is a rare member of the advisory profession who will admit that it is impossible for them to know any more than you do about what is going to happen next.

Indeed, we have previously noted Wall Street Journal articles pointing out that many such advisors, based on their "market guessing," recommended clients overweight commodities and international stocks in 2007 and early 2008, with disastrous results. This is just one recent manifestation of what Professor Dunn was describing in 1939. We have previously described these issues in a series of posts about the "intermediary trap" problem, here, and in discussions of "sector rotation" such as this one.

It may come as a shock to some, to hear professional money managers admit that no one can predict the next market cycle. What does someone in the money management business do, if not some form of stock market guessing?

The answer is: fundamental research on good companies and other appropriate investment vehicles. Rather than focusing on the unpredictable moves of market cycles, we believe in focusing on the business elements of the companies that issue stocks and bonds (and preferred stocks, and commercial paper). These business elements can be analyzed in order to discover well-run businesses operating in fertile fields of growth, as well as to predict when a company no longer fits into that category.

We firmly believe that this approach is far more reliable than "stock market guessing." Professor Dunn ended his address with a call to "all members of that profession" to "make clear their own position with no hesitation or compromise" -- in other words, to declare that stock market guessing is a delusion -- "and second, to consider all possible means by which they may effectively aid in spreading more widely what I have attempted to define as the true investment gospel." It is in this second capacity that we have published this post, and the rest of the content of the Taylor Frigon Advisor, and ask your help in passing it along to others who would find it beneficial.

For later posts on the same subject, see also: