The folly of trying to predict the stock market

Jan 15, 2013

Investors encounter numerous indices claiming to predict the future. Some are ridiculous, and some are based on facts. But most are worthless.

This week on Money Matters, financial commentator Greg Heberlein and KPLU’s Dave Meyer look at the January effect, sports indicators, and the fear index.

Something we always hear about this time of year is the January indicator. Supposedly, if the market is higher after the first five trading days of the year, stocks will rise for the month as a whole. If the market is up at the end of January, it will end the year up. It's sort of the Wall Street equivalent of Groundhog's Day. 

Take football’s Super Bowl index. It claims that if an original National Football League team wins, the stock market will rise for the year, and if other teams win, the market will fall. When it worked 12 of the first 13 Super Bowls, investors laughed, but in a way they embraced it. 

Over the years, its great record faded. In all 45 Super Bowls, it still worked 35 times. But in the past 15 years, it has worked only eight times.

The theory took a near fatal hit five years ago. An old NFL team, the New York Giants, won, but instead of a plus year, stocks suffered some of the worst losses since the Great Depression.

Nutty folklore also claims that if the New York Mets win the World Series, or if a horse wins the Triple Crown, the market will be in trouble.

Many indices aren’t so weird. They take statistics from the past to predict what’s to come. But you need to remember a key Wall Street disclaimer:  past performance is no guarantee of future results.

One index gets a lot of media attention. The VIX is the Chicago Board Options Exchange Market Index, more commonly known as the fear index. 

The index measures activity in stock-market options. If the number rises, investors are more fearful. Using time-tested contrarian views, that means the market’s chance of rising goes up. If the VIX is sinking, investors are getting complacent and the likelihood is that the market will decline.

Does this work? On the higher VIX numbers, a majority of the time the market does rise.  But on the declining VIX numbers, more often than not, the market doesn’t go down.

The VIX has been around 26 years, and a lot of market folks give it great credibility.  But skepticism is mounting. 

Buying index options is a way to protect your portfolio from sudden downdrafts.

Critics say that because the Federal Reserve is printing more money, investors are less likely to be fearful because more money in circulation tends to increase stock-market investing. With European economies in trouble and this country’s fiscal picture cloudy, many investors either have left the market or have remained in, but aren’t buying or selling. Those factors aren’t reflected in the VIX.

A number of exchange-traded funds track the VIX. Four of the big ones lost value in 2012, when the Standard & Poor’s 500 stock index rose nearly 14 percent.

Greg's own tracking leads him to believe the VIX mirrors past performance as much or more as future performance.

Indices can suggest market direction. But you can still lose your shirt betting on them, especially when they are like the VIX, which predicts shorter-term moves. 

The success rate of the Super Bowl theory, the January indicator and the VIX all pretty much match what normally happens anyway. 

In more than a century, stocks have risen 75 percent of the time.

So buy stocks and hold them. Over time, no matter what the predictions suggest, your money will grow.