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October 4, 2023

Interest Rates? Wait, Where's My Lucky Coin...?

Interest rates? Bond Yields? Just Flip A Coin.

Albert Einstein dies and goes to heaven, where he discovers that he has four roommates.

"Hello, Professor Einstein," says the first. "I hope you don't mind, but my IQ is only 160."

"That's alright," says the great man. "We can always discuss particle physics."

"Delighted to meet you, Professor Einstein," says the second roommate. "My IQ is only 140."

"Don't worry about it," Einstein replies graciously. "We'll just talk about mathematics."

"Hello, Professor," says the third. "I'm glad to meet you, but my IQ is only 120."

"Think nothing of it," Einstein says. "We can discuss literature and art."

The fourth roommate, after some hesitation, says, "It's an honor to make your acquaintance, sir, but my IQ is only 75."

"That's wonderful!" says Einstein. "Tell me Which way are interest rates headed?"

We don't even want to tell you what some Wall Street strategists get paid for predicting interest rates and the resulting trends, because you'd faint if you knew. Especially since first of all, those predictions aren't guaranteed (your refrigerator is guaranteed for 12 months and you paid less than $1,000 for that, retail), and second, those folks, more often than not, are wrong.

Since a bond can only go higher, lower, or do nothing, you should be able to call it right 33% of the time without trying. But according to one 19-year-long study, these "experts" correctly called the direction of change six months out in the yield curve only 28% of the time.

And how do you think they did at predicting what the long yield would be in six months? Within four or five basis points? Fifteen basis points? No; they were off an average of 87 basis points. Take their advice today, and a year from now you're poorer.

Wait, it gets funnier

Twelve-month forecasts were less than accurate, too. In late 1998, their average 12-month prediction for the 30-year Treasury bond's yield at the end of 1999 was roughly 5.6%. What it ended up was 6.4%. A year later they predicted that by the end of 2000, the yield would be 6.4%. As we recall, the yield at the end of last year was 5.5% 110 basis points under the prediction.

It's often the same with stocks, for the simple and immutable reason that stock pickers travel in packs. Rather than attempting to forecast correctly and independently, Wall Streeters evidently aim to agree with one another. (That way, nobody's feelings get hurt and if they're wrong, they can all weep together.)

On Wall Street, the expectations of tomorrow are already reflected in the prices of today; by the time a pick becomes common knowledge, it's probably time to short it. Unless an investor has superb timing, and can jump in at the low and out at the high (or knows someone who can), it's getting hard to make real money by following the pack.

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