At year-end, predictions about market gloom or doom for 2017 are coming from all directions, tempting even smart investors to play the old loser’s game of forecasting market prices.
The closing of 2016 brings not only New Year’s Day but encouragement to hope for a better 2017. Investors are bombarded by media, junk mail and email with often “shocking” announcements of portentous events. These predictions are usually accompanied by buying or selling investments, aimed (A) at avoiding a portfolio losses or (B) getting in on a new “great” scheme in purchasing stocks, bonds, or commodities. Someone will make money, but likely not those investors.
When faced with unsolicited recommendations from friends or relatives, or even neighbors or colleagues at New Year’s Eve activities, it would be wise to remember that informed investors with a professional investment management strategy are likely better served by sticking with their plan rather than emotionally reacting to opinions of others who can only know a tiny piece of all that enormous dispersed information available worldwide.
predictions and portfolios
Forecasters never say: “Capital markets are expected to continue to function normally,” or “It’s unclear how possible future events will impact future prices.” That is boring, and will never get anyone’s attention. Media predictions come in all shapes and sizes, but their purpose is to engage their audience’s imagination and then their pocketbooks into playing the traditional “outguess the market” game. Examples of predictions might include: “We don’t like gold in 2017,” or “We expect interest rates to rise sharply year.” Bold predictions may pique a morbid curiosity, but the efficacy of chasing a quick buck or being cozy in cash may not be so smart, and may cause a great deal of unnecessary stress.
Steve Forbes, the publisher of Forbes Magazine, once remarked, “You make more money selling advice than following it. It’s one of the things we count on in the magazine business—along with the short memory of our readers.”1 Definitive recommendations of forecasting gurus for “special” stock or ETF sector values may encourage those investors with past losses or who have not been saving to listen intently and then take quick action. But how accurate must that guru’s market predictions be to successfully grow real wealth over time compared to simply maintaining a professionally allocated management strategy?
Consider a common situation nowadays where an investor listens to predictions claiming that equities are priced “too high,” so that investors would be “better off” to sell now and hold cash. Let’s say that the guru’s prediction has a 50% chance of being accurate (equities will underperform cash for at least some brief period each year, to be sure): Will our investor actually have a 50% chance of finding themselves wealthier?
Remember — a market-timing decision involves not one, but TWO decisions. If the investor decides to switch out of a sensible equity position, they are forced to make a second decision: when do they resume their prior (or similar) market positions?
Let’s assign a 50% probability of the investor getting both decisions right. Mathematically our investor has only a one-in-four chance of being better off (0.5 X 0.5 = 0.25). Now let us assume our guru really is smarter than average, so that his chances of being right are 70% for each decision. Still, the odds of being better off are still shy of 50%, which is still no better than a coin flip (0.70 X 0.70 = 0.49). This result does not consider the negative impact of overcoming taxes, trading costs or incurring stress. This same logic applies to conventional market timing schemes promoted by financial advisors. The only guarantee market timing investors have using forecasts is that they will incur additional transaction costs.
The empirical evidence does not support traditional mutual fund and money managers attempting to profit from predicting stock or market mispricing. Exhibit 1 below, which shows S&P’s SPIVA Scorecard from midyear 2016, highlights how fund managers of U. S. stock portfolios in aggregate have fared against comparative S&P index benchmarks which are not actively traded or market-timed. It’s a loser’s game even for these highly skilled professionals who do it full-time. The majority of money managers must underperform over both short and longer horizons simply due to high transaction costs — and Exhibit 1 illustrates only surviving funds that did not close, which presumably did not do very well.
Rather than trusting forecasts from media “experts,” and futilely deciding which one to have faith in, investors can decide to find a trusted advisor to plan a wise strategy for the financial markets to most effectively process all that dispersed information. Millions of willing buyers and sellers, all of whom have a small bit of information, interact. The prices they set in the markets aggregate all that widely dispersed information in the form of stock and bond prices. While realized returns differ from expected returns, such differences are unpredictable. But we know for certain that the price of securities actively traded on platforms always reflects a positive expected return.
Over a long-term planning horizon, the case for trusting an informed market-based investing strategy instead of one that depends on forecasting is clear. Exhibit 2 below, shows the growth of a US dollar simply invested in diversified global equity markets from 1970 through 2015. A sample of several bearish headlines of the time are highlighted. Investors reacting negatively to these headlines and who moved to the safety of cash, could have potentially missed out on periods of substantial growth — much like many who panicked back in 2008—09, only to return long after equity markets had recovered and those returns were gone forever for them.
The roll call of forecasts responding to depressing headlines is unending. It’s true the U. S., the world and the global economy face serious challenges, but the future is unpredictable. Significant advances don’t make the front pages of many daily newspapers or the lead items in the TV news:
- Over the last 45 years one dollar invested in a global portfolio of stocks would have grown to more than $45, incorporating an enormous growth of wealth not only in the U. S., but worldwide.2
- 2 billion people globally have moved out of extreme poverty over the last 25 years, according to the latest United Nations Human Development Report.3
- Globally, life expectancy continues to improve dramatically. From 2000 to 2015 the global increase was 5.0 years. Mortality for children under 5 has fallen 53% over only the last 25 years.4
The mass starvation from a global population explosion popularly predicted back in the 1970s never occurred. Advances in science and technology, with international cooperation, can lead to new unforeseen new business and investment opportunities. Of course, not all developments will succeed. But the important point is that not only have developed countries grown wealthy — innovation from scientific research and business innovation has helped people in poor countries as well. Mobile phones have had enormous business benefits for the poor in third world countries no one predicted. So even when the worst of times are forecast, there is hope for the future. And capital markets finance that future.
As 2016 closes, it is natural to reflect on what has gone well and how to improve what did not. For planning successful wealth management strategies, we believe investors are better served by focusing on what they can control, such as diversifying broadly, minimizing taxes, and reducing costs and turnover. Those who constantly make investment changes reacting to short-term predictions, or switching funds or advisors frequently, are usually disappointed. The only certain prediction about markets is that future returns are uncertain. History has shown, however, that informed investors with a sensible strategy have been rewarded by planning and not by predicting the market’s unknowable prices.
- 1Excerpt from presentation at the Anderson School of Management, University of California, Los Angeles, April 15, 2003.
- 2See Exhibit 2.
- 3“Human Development Report 2015: Work for Human Development,” United Nations
- 4“World Health Statistics 2016,” World Health Organization