It’s human nature to try and make sense out of chaos. But sometimes, we just end up making things a lot worse…
Dec. 31, 2021
Joseph Kennedy is probably best remembered as the patriarch of a family that dominated American politics for the middle part of the twentieth-century. He was also a prominent politician himself, serving as America’s Ambassador to the United Kingdom in the early part of World War II.
But before that, he was a hugely successful investor. Kennedy became a multimillionaire during the 1920s bull run and then shorted the market right before the Great Depression, making himself even more money.
Legend has it that he decided to short when a young boy shining his shoes started giving him stock tips. This, to him, was a sign that rampant speculation had taken over and that a crash was imminent.
Another successful soothsayer of the 1920 bull market was an investor called Roger Babson. On the eve of the 1929 crash, he famously told a business conference in Massachusetts, “sooner or later a crash is coming, and it may be terrific.”
Of course, the problem with that is that he’d been saying the same thing for years. He just happened to be correct that time. Even a stopped clock is right twice a day.
Human beings are uncomfortable with chaos
Our entire history has been one of trying to find patterns in all aspects of our world — from the turning of tides to the movement of the stars.
Factor in an opportunity to make easy money and then the stock market becomes the Mount Everest of pattern seekers. Like alchemists, they all hope to find some secret formula that will turn lead into gold.
Back in 1926, a Wharton economist named George Taylor presented what he called the ‘Hemline Index’. In it, he argued that the hemline of women’s dresses were a leading indicator of the stock market. When women wore shorter skirts, the stock market was supposed to rise and vice versa.
“Buy on the canons, sell on the trumpets” is an old Wall Street saying, claiming you should invest at the start of a war and sell when it ends.
Or the “big buildings, big selloff” adage, which maintains that whenever a country builds the world’s tallest building, economic downturn is sure to follow.
The Empire State and Chrysler buildings were completed just before the Great Depression. The 1974 bear market was preceded by the building of the Sears Tower. Currently, the tallest building in world is The Burj Khalifa in Dubai, which was completed in 2008. No prizes for guessing what happened just after that…
Some investors even believe that the team that wins the Super Bowl is a determining factor. If a team from the National Football Conference wins, it’s time to invest. If it’s an American Conference Team, get out while you can.
That last “stock market predictor” is actually one of the more interesting ones to me because it shows the incredible lengths people will go to in order to try one-up the system. Part of me would love to meet the guy who one day thought the outcome of a football game could predict the future of the economy.
In fairness, the Super Bowl indicator has proven correct in about 80% of cases.
However, if you had predicted a good year ahead when the New York Giants won in 2008, you would have lost your life savings.
Correlation does not imply causation
We can find correlations everywhere if we look hard enough. There’s actually a book called ‘Spurious Correlations‘ by Tyler Vigen in which he finds links between things like the divorce rate in Maine and the per capita consumption of margarine.
In truth, there is absolutely no way to predict what’s going to happen in the stock market. Anyone who tells you otherwise is lying. Most economists can’t even agree on what caused a recession, let alone tell you when the next one is coming.
Instead, I like to look back at what’s happened before and make reasonable assumptions as best I can.
The stock market has historically returned around 10% per year, on average. Though it’s no guarantee, it’s reasonable to assume that it will continue to do so into the future.
That means that if you invest $10,000 into the stock market, and add $2,000 a year (not forgetting compound interest), in 30 years you should be sitting on something close to half a million dollars.
There’s no witchcraft or alchemy involved in that. You don’t need to check what’s going on in the world of skyscrapers. You don’t need to get your tape measure out the next time you see a group of women walking down the street — unless you want to get arrested, of course.
Long-term buy and hold investing is a proven wealth creation vehicle that’s available to everyone. What we perceive as chaotic is actually quite predictable over a long enough timeline.
Those who try to find the short term patterns are the ones making it complicated.