April 17, 2014 6:37 pm

How to tell a Cassandra from an Oracle

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Last month, we covered how to tell if your adviser is putting you first – developing a plan to reach your long-term financial goals and giving you the tough-love advice you need to reach them. You-first advisers won’t indulge your fear and greed impulses, won’t encourage you to zig and zag.

While zigzagging is bad, sometimes big tactical moves may make sense. If your adviser foresees a bear market – a big, long drop of 20 per cent or more – forming in stocks, then moving to cash or bonds might be wise. But such market timing is difficult. When he screams, “get out”, how can you know if he is even possibly right? How do you tell a potential Oracle from a Cassandra?

In Greek myth, Cassandra was the mad seer – disaster was always nearby. Rather like most newspapers’ front pages or the beginning of the business sections. The doom-and-gloom media are a chorus of Cassandras.

If everyone is singing about something, you can bet markets have already moved on it. Markets pretty quickly discount all widely discussed information. You can’t get more widely discussed than risk-hogging headlines. If it’s on your front page, if it’s all over the internet, on your radio and your telly, ignore it. Consider how quickly markets move on every economic data release, earnings announcement and Twitter rumour – microseconds! Markets are just as efficient with media blather.

Are your adviser’s warnings based on risks you read about every day? Does he warn of unbalanced recovery and big current account deficits in Britain? A hard landing in China? Vladimir Putin waging war with the West? Nuclear North Korea firing at Seoul? Too-high stock valuations that can’t possibly be supported by earnings? Or too-high profits that mean businesses aren’t investing and will grind growth to a halt?

Does he tell you to run from a eurozone deflation death spiral or too-big-to-fail banks, or suggest you scurry into cash before Mark Carney and Janet Yellen hike short-term rates? Is he (or she) advising you to flee before the Fed kills emerging markets by ending quantitative easing (QE) and starting a currency crisis?

If so, he’s a Cassandra. All of these – and more – have dominated headlines in Britain and the US for months, years in some cases. Whether they’re correct or not, all the fear and doomsday expectations are baked into current prices.

Could they rattle markets still? Sure – short-term, anything is possible. Spiking fear for any reason – or even no reason – can drive volatility. Fears of QE “tapering” had circulated for months when 2014 began, but markets still got spooked when currency slides in Turkey and Argentina prompted another round of taper terror in January.

Quick pullbacks and corrections are impossible to time. Try, and you mostly end up selling low and buying high. If you look at index tracker fund flows in January, you see outflows spiked at the bottom of that late-month pullback. But within two weeks, stocks were back above break-even, and fear-based sellers were out in the cold. Some might still sit in cash, waiting for an all-clear signal that will never come. Such big opportunity costs can jeopardise your financial future.

You need an adviser who understands how markets function and has the wisdom to separate the news from the noise. Someone who won’t interpret a quick dip as confirmation Cassandra was right and pull you out of stocks at just the wrong time.

Oracles know bear markets usually start in one of two ways. Either investors are too euphoric and there is no “wall of worry” for the bull market to climb. Or a big, ugly, unseen development knocks stocks off course. Sometimes both. Surprises, not noise.

They know to look for surprises. Successful forecasting – which merely means being right more often than wrong – requires looking where others aren’t. Today, the herd thinks banks are a bust because they still haven’t come back from 2008. But the wise man sees a widening interest rate spread as fuel for fat gross profit margins. He sees opportunity in banks and looks elsewhere for risks – like energy and materials, where firms have little or no pricing power and slim gross margins.

If headlines focus on one corner of the world, your adviser should look globally for overlooked risks and opportunities. If the herd assumes some new policy development – maybe big trade restrictions to “protect” jobs – is good or bad, he should know it’s already priced in.

If your adviser can see the world differently and think for himself, that’s good. But if he follows the fear-mongering headline herd, then beware the Cassandra trap.

Ken Fisher is the founder and chief executive of Fisher Investments

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Letter in response to this article:

Cassandra was correct but not believed / From Mr Paul A Hendrick

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