Grim Market Outlook

One of the reasons I have a Random Thoughts section on my blog is because, well, I can talk about anything I want. I have never had a real main focus other than maybe physics, philosophy, and future speculation. However, from time to time I like to talk about other things that interested me and one of those is finance.

I came across this gem the other day, and man it is depressing! I am 30 years old so retirement is something that most people my age do not think about. Mainly because it is sooooooo far away. But as you might expect I am not the normal 30 year old and retirement is something I think about quite often. When I do a quick analysis of my 401K and my other savings accounts I can quickly deduce that I will not have enough to retire comfortably. Which is very alarming for so many reasons. I have been thinking for a while that I, and my generation, may not be able to retire at all for a variety of reasons. Which again is very scary.

Let’s take a look at a few things. First, the historical returns of the market from 1950 to 2009 was about 7%. Which is a really nice return on your money over that time period. The article states higher returns for the last 30 years of about 7.9% which again is nice, but I am not going to squabble over 1%. Again if I told you that you could get 7% return on your money for the next 30 years I think almost everyone would jump all over that investment. However, as the article states those historic returns are just that, a thing of the past. The future returns that these “experts” are suggesting are troubling.

To start I would like to say that I am obviously by no means a financial expert, but I do understand certain things about the market and the economy. I will say that when it comes to things like this especially when dealing with the market when it really comes down to it, it is really just a best guess. Now I am sure if I asked them they would tell me that they have some super advanced model that they used to determine their rates of return. But at the end of the day they are still trying to predict the future, and I would promptly go ask them to talk to a meteorologist on how easy that is, and they are usually trying to predict something just a few hours to days out. Now when you try to do that for a few years to the better part of a decade, that really makes me question their findings.

There is a well-known saying that says, correlation does not equal causation, and there is also something that states, using past performance to predict the future returns is not a good idea. Anyone who is involved in making models will tell you this. The problem is that we have no other way to make future predictions when it comes to the market, this is basically all we have. Does that make this prediction absolute, hardly! In my opinion there are way too many aspects at play to take seriously what this article is saying. Now I am not going to out and out say they are wrong, but I will say that there is a very small chance they are right. I would be much more inclined to believe them if they were talking about the next few years, instead of decades. There is way too much political upheaval that could take place to give a hard prediction on market returns that far in the future.

We will talk probabilities and game theory in a second but first I want to discuss the economy and business in general. Throughout the last 100 years of America’s existence we have seen unparalleled gains for the most part. The majority of that was due to the fact that we were an economy mostly based in manufacturing. That was what has driven much of our economic growth over the years, especially in the 50’s and 60’s. But recently in the last 10 to 15 years we have sort of gotten away from this model and now we are more focused on the services industry and a service based economy. So that aspect of the economy has changed quite a bit. Quite a lot of the lucrative manufacturing jobs that got us to where we are today are no longer out there, they have either been sent overseas or replaced by more efficient or cheaper technology. In my opinion I would argue that perhaps neither of these things was anticipated 20 to 30 years ago. If you told someone in the 1960 that in 30 years almost all manufacturing jobs would be sent to China they would have probably laughed at you, but that is what has happened. The point I am trying to illustrate here is that it is near impossible to predict what will happen economically in the next 5 years much less the next 20 years or so.

In my opinion there is way too much volatility in terms of technology and politically to make the predictions that the article states. We have no idea what the next phase of economic advancement will be and what sector will drive that advancement. I would say that it would have something to do with robotics and or even artificial intelligence. If you listen to the so called “experts” they claim that AI is just around the corner. I am not that optimistic but I would be willing to bet that in the next 10 years something will come about that could revolutionize not only this field but also reshape the economy. I will certainly make the claim that if, and that is a big if, we somehow figure out AI that all bets are off and the future of the economy and so many other aspects of our lives will be drastically changed. I am not saying that AI will save us, but I am saying that this technology could spark the explosion that the economy needs to completely negate everything that is stated in the article. We do not know what kind of industry and or jobs will be created when and or if this happens. There are literally endless possibilities of the types of jobs that advanced technology could create.

Now with all that being said let’s take a look at a few other things that have to do with predicting the future. One famous idea is what is called the Gamblers Fallacy. Which states that the next event is predictable because of the last few events have led to a pattern at least in your mind. Think of the Roulette Wheel, you have been sitting there for 20 minutes watching that stupid ball go around. The last 5 turns have all landed on Black, so using you superior intellect you decide to bet your life savings on Red. The next turn has to be red, because the last 5 have been black, which makes sense. You place your bet and watch the ball go around as your heart races, you are of course about to be rich beyond your wildest dreams. But the ball bounces and finally comes to a complete stop. BLACK, you lose. Your mind races, what could have happened, you logic was flawless. Well not really, you are forgetting that the last turn has nothing to do with the next one. Meaning that there is nothing preventing the exact same outcome from happening again and again and again. Think also of flipping a coin, there is an equal 50/50 chance every time you throw it. Now you may think that the last 20 times it has landed on tails so the next one will be heads, but the same principle applies. It could be tails another 20 times in a row, again because nothing is preventing that same outcome from happening again.

So what does my long winded explanation have to do with anything, well the psychology behind this would be basically the same as with any other aspect of our lives, including the economy and the market. Just because we see a pattern forming in the past does not mean that the opposite is due to happen in the future. Although there are certainly quite a few more moving parts to the economy I still think some of this idea applies. I think we have never had more than 7 years of positive gains before some sort of correction in the market. Corrections happen often in the market usually on average about every 365 days, so basically once a year the market will readjust itself because of inflated prices. What I find interesting is that we have never had more than 7 years up in the market, that is very interesting. BUT now that more and more people will know and understand this phenomenon I think it could possibly become less of an issue. Remember there is also a very real and very powerful psychological aspect to the market. The thing to keep in mind here is that with the Gamblers Fallacy each outcome is independent of the previous, where as in the real world dealing with economics and politics most of the time outcomes build on one another. So that each outcome is more or less dependent on the previous. So for that we will need to incorporate a new idea.

Game theory is very interesting, and for the most part I do not understand it as a whole. At its base it is a theory that tries to quantify economic, political, and or other human activities and the choices they will make. Using Game Theory would be the best way to predict the future. So, again in my opinion, I think the article could have and should have extensively used Game Theory in its projections, however it the article does not anything about that. So I do not think that using past market actuals, only, to try and predict what will happen in the future is a very sound idea. I also want to be clear that the article really makes no mention on what model they used or how they came up with this prediction. So they very well could have used game theory and any other number of variables to come to this conclusion. So if that is the case then I will give a little more credence to what the article says.

Again I think there are way too many variables to really give a solid prediction on the market future. If you love or hate Obama he will more than likely go down as the 4th worst president if he does not reach 3% GDP in his last few quarters of his presidency, which all indications indicate that he will not. And here is a second article again confirming what the first is saying as the source is a little unknown to me. I am not picking a side just simply stating a fact and one that I am sure went into the analysis of the article. The past eight years have not been great by any measure economically, so I think that also could have played into the bleak outlook they predicted. I don’t want to get political but I think the next president no matter who it will be is a very important one because of the economy.

I am still a believer that a new technological revolution will happen in the next 10 years or so, which could create another booming economy much like the tech and housing bubbles. BUT this growth would not be a bubble, but the real growth that we are so desperately looking for. I am not sure if that is just my hope or if I truly believe that…

Manik

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