Prediction or repeating history?

By DAVID MOON, Moon Capital Management, LLC
July 6, 2008

A large brokerage firm recently issued a research report that contained a startling prediction.

After analyzing the data, poring over his spreadsheets and reading his tea leaves, the analyst concluded that the U.S. stock market was likely to stay within a fairly narrow trading range over the next several years ' possibly as long as eight years.

In other words, his forecast was that stock returns might be as little as zero for most of the next decade.

Had this been a call-in show, I might have been tempted to pick up the phone and share my own predictions. Things like an impending weakness in the residential real estate market or a decline in the prices of bank stocks. I might even predict the demise of IdleAire or that Archie Manning's sons would win back-to-back Super Bowl MVP awards.

And I would have a whole bunch of Knox County political predictions.

The guy calling for a flat stock market took the last eight years' worth of data and simply predicted that it would repeat. I thought I was listening to a history class rather than a discussion about current investment strategy.

On January 10, 2000, the Dow Jones Industrial Average closed at 11,723. In May the following year, it closed at about 11,000. By September 2006, it was back to its original level of 11,700. This past week, almost two years later, we were below 11,400.

That's 8' years, and a total return from capital appreciation of negative 2.76 percent.

In the interim, it has been as high as 14,000 and as low as 7,700.

Some mighty big and profitable companies have fallen. Microsoft has declined from a high of $57 a share to $26.45. General Electric is still 54 percent below its 2000 peak price. Home Depot has declined 60 percent.

And these are profitable companies.

After all this pain and spinning of wheels, surely there are some lessons. There are always lessons.

The stock prices of profitable companies can decline. There are plenty of reasons for this. Sometimes the price of the stock is too high to begin with. Other times a stock price will decline in sympathy with an overall market sell-off or negative news within a specific industry. But just because a company is profitable and expects to remain so doesn't guarantee that its stock price will increase from its present level.

Don't try to time the market. You've heard it repeatedly. If you try, there are only two things that can happen.

If you fail, you will end up buying high and selling low, which will cost you money.

Worse, however, you might succeed. Maybe you'll manage to get out of stocks at a market peak or get in at a market bottom. If so, you're likely to think you can do it again. That's like thinking you're good at picking heads and tails. It's simply luck. Eventually you're going to lose. And the longer you win, the more you're likely to bet on each succeeding gamble.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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