Predictions Based on Past Market Performance Are a Waste of Time

Now that 2013 is in the books, investors have been flooded with market predictions for 2014. My colleague Dan Caplinger recently noted how wrong the market pundits have been in the past, as he pointed out, among other things, why the motives fueling predictions can interfere with the predictions themselves. Yet a lot of pundits are using a particular set of stats to predict another winning 12 months in the market.

Their argument hinges on the S&P 500's (SNPINDEX: ^GSPC  ) 29.6% gain in 2013. Since 1950, the S&P has risen more than 25% 12 times, and if you average out all the years since 1950, the index has risen 9% annually. However, in the years following those 25% gains, the market has averaged an 11% gain the following year. Furthermore, the market has finished in the black 83% of the time following those years of 25% gains, while averaging across every year since 1950, the market has risen only 73% of the time the next year.  

Sure, those are some impressive numbers. But as financial advisors and prospectuses constantly remind us, past performance is not indicative of future results. Besides, it's not as if the S&P was the only big gainer last year. The Dow Jones Industrial Average (DJINDICES: ^DJI  ) increased by 26.5%, and the Nasdaq rose an amazing 38.32%. 

But why does it matter what the overall markets do anyway? If you're picking individual stocks believing that you can beat the market, then focusing on what those companies are doing and will do is the only thing that should matter -- not how the S&P 500 or the Dow will do in 2014. 

Most investors believe that the market is a forward-looking entity, and that's why stocks are priced based on what a company is expected to do in the future. So whether you're making your own predictions or listening to someones else's, make sure they're based on what an individual stock is poised to do in the coming year, not what it's done in the past or how the major indexes performed. Focus on things like expected future cash flows, profit forecasts from management, planned product launches, and other revenue drivers, and base your buy and sell decisions on those factors -- not what the company has done for you lately, and not what it did last year.

People like to use whatever data points they can find to feel more legitimate about their investing choices, despite the fact that they're often violating some basic rules of stock investing. The bottom line: Any investing prediction based on past events is a waste of your time. Look forward, not back.

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