Those Spurious Presidential Futures

But even with the colossal sums involved, the stock markets' predictive track record has been spotty at best. It is an old Wall Street joke that the "the stock market has predicted 10 of the past four recessions." The market's inaccuracy is in part due to the simple fact that the future is inherently unknowable. Additionally, the impact of unanticipated events further degrades markets' predictive record.

My feeling on the utility of these devices starts with the simple observation that markets do not predict the future. Investors will find that it is much more useful to consider markets as future discounting mechanisms that capitalize on the balancing of increased risk with potentially greater reward.

The discounting function is cyclical. As investors begin to believe that future gains have become more difficult to achieve, they are less willing to "pay up" for stocks. The decreased demand leads to lower prices, and demand doesn't pick up until, eventually, these lower prices and the potential for greater upside entices more buyers to step back in.

Investor's expectations cause this discounting to occur. So while the markets are often telling us something, that's a very different and more nuanced idea than that of predicting the future.

Consider the Nasdaq since the market crashed in March 2000. The Nazz has enjoyed five rallies that delivered gains between 37.3% and 71.8%, yet the first four of these five rallies failed, each ultimately leading to new lows. While the move off the bottom in March 2003 has not fizzled (at least not yet), it raises an important question: What were these prior market moves "predicting?" At the time of each, the pundits were proclaiming a new economic expansion and/or a new bull market. It turns out they -- and the market's so-called forecast -- were wrong.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].