Commentary: Educated Investor - The trend is your friend

Well, it's that time of the year again when all the self proclaimed stock market geniuses make their forecasts for the coming year.

It doesn't matter if you are a cab driver, housewife, economist or strategist, we all have our opinions concerning what the year 2003 holds for the stock and bond markets.

These geniuses will predict what the major market indices, interest rates and just about any other class of financial assets you can imagine will do in the next 12 months, and their opinions will be all across the spectrums.

As a matter of fact, J.P. Morgan Chase & Co.'s three strategists have three very different predictions about the market's performance next year. They range from a 12 percent drop to a 16 percent rise for the S&P.

What has always amazed me about this exercise in futility is that the prognosticators all have access to the same data, yet their conclusions are varied and in many cases widely.

Does the problem boil down to the interpretation of current data or perhaps does the economist and portfolio strategist just see different outcomes occurring from the same set of circumstances?

Personally, I believe the global economy is so complex that it is virtually impossible to predict the future course of our financial market with any degree of certainty.

Yes, there have been individuals in the past that have made timely major market calls, but I don't believe it was due to any particular expertise on their parts. Rather, I think the markets were responding to a multitude of variables that one individual could never correctly evaluate, and the gurus were just predicting when the market came their way.

In others words, luck was on their side. If the market callers did have some special insight they would have continued to make all the right calls, which they haven't. They have had their 15 minutes of fame, but are no longer on center stage.

I refer to these individuals as unconscious competence. The market went their way, but not necessarily for their rationales.

The stock market not only responds to a multitude of various elements, but the variables themselves all have effects on each other.

For example, under normal circumstances if interest rates rise, the dollar should also strengthen, but with a potential war in Iraq, a geopolitical variable, one would see the dollar weaken. Therefore, depending not only upon the combination of variables at work, but the real time importance of each variable, the financial markets' reaction will vary.

Now if you only had three variables as mentioned above influencing the market, then you would have a better chance of determining the future behavior of the stock market. Why, because mathematically there would only be six possible scenarios involving the three variables (3 x 2 x 1 = 6).

Unfortunately, for investors, the interrelationship between the variables and the resulting outcomes are too numerous to be understood by investors.

One would have to be able to predict the behavior of variables such as price of commodities, union actions (West Coast Lockout), geopolitical risk (Iraqi War), unemployment, consumer confidence, money supply, CPI., P.P.I., foreign national economies, etc. And these are only a handful of the many variables that effect our economy and ultimately our stock and bond markets.

Since these factors not only effect the market but each other, trying to predict the market is like trying to win your local super lottery. I doubt if any individual can determine the overall effect these combinations would have on the stock market with any degree of consistency.

So what is an investor to do with all the forecasts they are bombarded with? Use them as a form of entertainment and nothing more.

Instead of peering 12 months down the road, and trying to predict the market's future, look day to day for your direction. Use the current market trend for your guidance, and until some dramatic changes occurs within the major variables stay the course. There is an old saying in the investment business the trend is your friend and believe me nothing could be truer.

Right now we are in a trading range within a bearish tone. Until that changes, invest accordingly. This means you want to look for individual stocks that can appreciate in a trading market and at the same time you need to pay attention to the overall downside risk.

Therefore, in addition to searching for those needles in a haystack, you need some short term cash investments such as money markets, and you should hedge yourself by investing on the short side.

Since 90 percent of the value of any stock is determined by the overall market you need to be especially cautious in selecting stocks in a bearish trend. Look for companies that fill a niche and have great balance sheets.

As far as your short positions are concerned, don't go it alone. Look for a no-load index mutual fund that shorts the S&P 500. A fund will limit your downside risk.

Depending on your age and circumstances keep some cash in a money market fund for future additions to your portfolio or trading opportunities.

For those of you that might want an aggressive investment strategy for the coming year you can check my Web site at www.theeducatedinvestor.info and click on to model portfolios.

If you only remember one thing from today's column, always keep in mind the trend is your friend and forget about future market predictions. Our world is far to complicated to foresee the long term effects on our economy and therefore the future value of the major market indices.

David R. Clogg, ChFC is an account executive at Chapin, Davis. He can be reached at 410-435-3200 or visit his Web site at www.theeducatedinvestor.info.

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