As the New Year begins, many well-known stock market personalities have posted their guesses on where the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) will end 2014.
As entertaining as these predictions might be, the terrible track record that the industry's finest have in actually making accurate estimates should convince you once and for all that relying on those predictions is a potential ticket to disaster.
The problem with predictions
In general, market predictions about the stock market fall into two general categories.
Among major firms, you'll typically find predictions that reflect general bullishness or bearishness without taking extreme positions one way or the other.
For instance, coming into 2014, many forecasters are predicting the ASX to end the year around 8% to 10% higher at around 5,800, give or take a couple of hundred points.
In the other category, you can always expect to see some outlandish expectations. After five years of a bull market, most of these outlier predictions aim toward the downside.
For instance, in 2013, financial author Harry Dent predicted that the Dow would fall to 5,000. The bad call was just the latest in a series of failed bearish predictions for Dent after the 2011 publications of his book The Great Crash Ahead: Strategies for a World Turned Upside Down.
Here in Australia, financial commentator Vern Gowdie says stocks could fall 90% from the current level.
Understanding business motivations
Obviously, when you look at any prediction, you should consider the motivations of the company or person making that prediction.
For the big investment banks and other analysts, those making predictions are trying to put their clients at ease about the investment decisions their respective companies recommend while also setting themselves apart as being better at making accurate calls about the market.
Shareholders in those companies should want them to be smart about their predictions, avoiding going out on a limb that can bring scorn from the investing community and have a negative impact on their business. Yet few clients hold those banks accountable to their specific predictions, especially when their mistakes actually lead clients to make more money than they would have otherwise.
Before you look at any prediction, it's important to look back at the track record of whoever made the prediction. Yet even that can be misleading, as just because someone has been right before doesn't mean they'll be right again, and bad calls in the past might well turn into good ones for the future.
In the end, your best move with predictions is to look at them as entertainment, to draw your own conclusions from their reasoning, and to try to come up with your own analysis of where the Dow and the broader stock market is likely to move in the years to come.
