The Experts Couldn’t Be Easier to Beat
By Dr. Steve Sjuggerud, Advisory Panelist, Investment U“

This is the dumbest newsletter I’ve seen from you guys yet,” a reader said this week.

Apparently, he didn’t like the last Investment U E-Letter.

In it I said: “The Wall Street Journal polled 56 economists, and 55 agree: Long-term interest rates will rise in 2005. But wait! Don’t go making plans just yet“ Based on the track record of the “experts,” I said, interest rates actually have a better chance of falling in 2005 than rising.

This reader was flabbergasted: “Your logic can vaguely be compared to this statement: The person is dead. 55 out of 56 experts said the person is dead. But experts have consistently been wrong identifying his illness, so they are wrong now, too, and the person is not dead.”

You can appreciate his logic. Unfortunately, it will do nothing but lose him money in the markets.

Today I’ll hopefully prove once and for all that the “experts” aren’t hard to beat. Then I’ll show you how I track the “experts” to go against them.

Being Right or Making Money

Do you want to be right, or do you want to make money? That’s the question. I’m trying to make you money. This reader isn’t getting my point. So let me reiterate: When the experts all agree, you’re likely better off doing the opposite than doing what they say. A few examples…

“Bonds Looks Horrible - Perfect Time to Buy?” That was the headline of the May 16, 2004 Investment U. In it, I said, “I couldn’t believe it when I read that only 1.4% of professional investors were bullish on Treasury bonds.” If you had bought bonds then, you’d have made a pile of money. Bonds soared (yields came down), and even conservative bond investments were up by 10% or more.

On Dec. 28, in my True Wealth Tuesday blast e-mail to my readers, I wrote: “I expect the big surprise of 2005 could likely be a big strengthening in the value of the U.S. dollar.” Almost starting immediately, the dollar then strengthened by 4%, confounding the “experts” who nearly unanimously predict dollar weakness in 2005.

The Dec. 30 Investment U E-Letter was titled: Investor Sentiment Indicators: Ominous Optimism. I reported that “all four of the major surveys of investor sentiment optimism are at extremes. In other words, people are excessively optimistic.” Nearly all the “experts” think the market will rise. Our reader (the one who agrees with 55 out of 56 doctors) would no doubt conclude that if all the experts think the market will rise, it’s now time to invest. Yet the market has fallen so far in 2005.

The Experts: Worse Than a Coin Toss

Was I just lucky?

No. The “experts” are habitually horrible performers.

David Dreman, in his excellent 1979 book Contrarian Investment Strategy, studied financial experts’ forecasts over the preceding 50 years (starting in 1929). Dreman found that the experts’ forecasts consistently, dramatically underperformed the stock market over 50 years. They only beat the market 23% of the time Said another way, the experts were wrong more than three times out of four!

Dreman said: “The findings startled me. While I believed the evidence clearly showed that experts made mistakes, I did not think the magnitude of their error would be as striking or as consistent.”

David Dreman gave many stunning examples. Here are two…

At the end of 1971, Institutional Investor magazine polled more than 150 money managers in 27 states for their top picks. By the end of 1974, the top 10 picks from those “experts” were down an average of 67%, horribly underperforming the market.

In February of 1970 in New York, at a conference of 2,000-plus institutional investors, the attendees were polled for what stock they thought would be the top performer in that year. The favorite was National Student Marketing. From its February high of 120, the shares of NSM dropped 95% in the next five months. A 95% fall!

At the same conference in 1972, the “experts” said airlines would be the best performer. The market rose in 1972, but the airlines fell by 50% that year.

You get the idea, I hope. I can’t comment on 55 out of 56 doctors. But I can tell you that when 55 out of 56 stock market pros think one thing, history shows you’re better off considering doing the opposite.

How to Track the Experts… So You Know What NOT to Do

My first source for keeping tabs on the crowd is Jason Goepfert’s website, http://www.SentimenTrader.com. Jason compiles more indicators on what the big money (and the little money) is saying and doing.

He tracks what they’re DOING by tracking money flows… into and out of puts and calls, into and out of sectors, etc.

And he tracks what they’re SAYING by tracking all the major polls of investors. (There are some organizations that simply subscribe to newsletters to determine the number of bulls and bears among stock market analysts.) Some of these polls go as far back as the 1960s. And, as you might guess, when all stock analysts are bullish, you don’t make any money in stocks.

You may find it interesting to learn that the major poll of investor sentiment (the Investor’s Intelligence poll, from http://www.chartcraft.com) recently found the largest percentage of bullish analysts since, well, 1987. Yes, the last time the “experts” were this optimistic on stocks was in the months preceding the Crash of 1987, where stocks lost over a quarter of their value in a day.

This reader is welcome to invest in stocks in 2005 because 55 out of 56 analysts believe the stock market will rise. With overwhelming evidence of the horrendous performance of analysts, particularly when they all believe the same thing, I’ll gladly take the other side of that bet.

Good investing,

Steve

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