Predicting Long Term Stock Market Return
Here is an article from MarketWatch.com on forecasting the stock market in year 2011. This is the second time that I’ve read about longer term forecasting in stock market. I think last time when I read about it was around year 2000. At that time, the forward 5 year prediction was not good.
To give you a summary, essentially using value line research, it has been shown that predicting stock market return in the next 3 to 5 years is actually “easier” than predicting the market in the short term. In the very short term, no one knows for certain whether the stock market will go up or down tomorrow. There are theories that stock market is more like random walk, and it is unpredictable. And if stock market is truly 100% efficient, there will not be any profitable opportunity that you can exploit, and therefore, you won’t be able to predict the short term direction of the market for profitable opportunities. Efficient Market Hypothesis (EMH) is almost golden in my opinion. But there are several cracks. One of which is exactly described in this article. It is simply easier to predict stock market for a longer timeframe, than a shorter timeframe. Why is that??
It means there are really information extractable from the current state of stock market and economy. While in the short term, you may not be able to predict the direction or amount of return. In the longer term, there are indeed investable information that you can extract. In my opinion, EMH has no concept of time, and I kind of agree that looking at every instant in the market, everything is indeed efficiently priced. But when you start to expand your time horizon longer, EMH will start to fail because there are some historical and current states in the market that can be extracted and extrapolated into the future, which cannot be reflected in the next minute or second.
Why do you want to invest (certain) stocks for the long term, instead of doing short term trading? This is the biggest reason that I believe. Because when you are able to identify and select certain stocks or sectors based on the current and past information, you will be able to outperform the market given enough time span for those information to unfold.
What was the prediction from the MarketWatch.com article for the stock market in year 2011 (5 years from now)? It appears to be not too good (go and read it yourself). I believe that US stock market in general is still in the secular bear market (but should have a short term rally towards the year end)? Currently US stock market is in the short cyclical bull market which is probably about to end quite soon in less than 6 months. Looking much further out, I don’t think the return adjusted by inflation will be great in the stock market. I don’t think index investing will make you rich in the next five or even ten years. You should be lucky to just preserve your buying power.
Just my two cents.