Why investors should give up predicting stockmarket crashes

Markets (as defined by the ASX200) are up about 115 per cent since their lows back in March 2009. Yet so many have wasted this run by sitting on large allocations of cash year after year, predicting imminent doomsday scenarios for markets for close to a decade.

Of course, I don’t have a crystal ball and I’m not making any judgement about whether markets will continue to go higher for many years to come, or there’ll be a crash tomorrow.

I’m making a point about what has been a lot of bearish sentiment year after year, despite an ongoing bull market. Many investors have been more focused on trying to pick the next crash than focus on investment decisions more evidently within their control.

Aussies are stockmarket pessimists

I think there are three reasons why so many Australian investors focus so much on trying to pick the next crash. These are:

1) The financial crisis of 2008 was one of the biggest we’ve seen in history, and it wasn’t that long ago so, for some, the scars are still raw. The phenomenon of loss aversion describes how the pain we experience when we lose something is twice as powerful as the emotion we experience when we gain something.

Yes, losses are powerful, but crashes do occur from time to time and we can’t let losses derail our long-term investment strategies.

2) We see negative predictions far more often than we see positive headlines because a negative headline is a great way to sell newspapers or get clicks. In Australia, when $104 billion was wiped off the share index in 2008 it was labelled ‘Black Tuesday’. In August 2015 when $60 billion was ‘torched’ on the sharemarket it was labelled ‘Bloody Monday’.

But how come there’s no name for the positive days we have too? There’s no name for positive days when the market goes up because they’re not as newsworthy. Be careful of using day-to-day headlines to guide your long-term investment strategy. It’s not a smooth ride but remember, historically, markets do go up over the long term.

3) People focus on trying to pick the next crash because if you keep saying it enough eventually you’ll be right. Like a broken clock, at some point it’ll be correct. Someone will be right eventually as corrections actually occur most years and crashes (despite not being as frequent) historically occur from time to time too.

But be warned. As Howard Marks once said: “Being too far ahead of your time is indistinguishable from being wrong”.

Beware the permanent stockmarket bears

Yes, there’s negative views out there, and there’s plenty of noise. Right now some people are forecasting the US could be entering a recession.

Well, at some point there will be a recession, so if you keep saying it enough you’ll be right eventually. But what gets little attention is that there’s also been positive news out there, stats that show the US is at a 50-year low for unemployment. Yes, a 50-year low!

It’s also very hard to differentiate between luck and skill with predictions. In football tipping competitions, some of the winners are often people who care very little about the game. They win because they’re lucky. If someone is accurate in predicting the next crash, is it possible to determine if it was genuine skill or they were just lucky?

A study by JP Morgan in the US found that six of the best 10 best days in the market over the past 20 years occurred within two weeks of the 10 worst days. So not only do you have to get the timing right when the crash is going to occur, you need to get the timing right for when to get back into the market.

Diversification is your protection

I don’t have a crystal ball. This bull run may continue, or it may not. To quote the great Howard Marks again, he recently wrote in one of his famous updates: “Whatever we knew in the past about how things worked, I think we know less when rates are negative”.

Historically, low interest rates certainly make something like predicting the future even more difficult.

Diversification protects against an unknown future. Focusing on smart ways to diversify, to lower your fees, invest for your appropriate risk return profile are genuine things that you can control yourself or with the assistance from a service like Six Park, where I work.

I’m not sure what 2020, next month or even tomorrow holds for the markets, but to quote a line from Peter Lynch that I love: “Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves”.

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.