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What Can Happen When You Listen to Market Predictions

Seth Jentner05/17/2013

In early 1999, many investors questioned the wisdom of investing in small cap stocks. For the ten-year period ending December 1998, the annualized return for small caps had trailed large cap stocks by 6% annually. As small stocks fell even further in the first quarter of 1999 amidst continuing large cap strength, the frustration was intense. Market observers advocated the long-term investment advantages of large cap firms and put the advocates of a diversified strategy on the defensive.

Here is a sample of what investors were reading at the time:

  • Dow Jones Asset Management, Jan/Feb 1999:  “If God is on the side of small company stocks, she is demanding much faith.”
  • Worth Magazine, February 1999:  “The time has come to examine a deep belief—the idea that small-company stocks will, in the long run, provide a higher return than large company stocks … Actual events don't support the idea …”
  • Business Week, March 1, 1999:  “The powerful economic forces such as disinflation, globalization, and profits growth that made large caps big winners are still firmly in place … Virtually every foreseeable trend favors large companies."
  • New York Times, March 21, 1999:  Interview with Prudential Securities director of small cap research Claudia Mott. “Right now there is no convincing reason to buy small caps …”
  • Forbes, April 6, 1999:  Kenneth Fisher of Fisher Investments wrote, “Sell smaller stocks, buy super-huge ones … that's been the way to make money and that's the way it's going to continue to be for quite a while.”

So what happened in the following decade? Small cap stocks outperformed large cap stocks by 7% annually.

The moral of the story:  Do not believe the market prognosticators. The future of the markets is unknowable. Instead, invest in a diversified portfolio of index funds representing large and small companies, as well as both stocks and bonds. Concentrated portfolios are not worth the risk!

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