02 Mar Avoid predicting the unpredictable
Image by nvodicka from Pixabay
Each year, investors face a barrage of commentary and speculation from the financial press about which stock, sector or country is set to do well in the coming months. The quotes below are taken from articles published by well-known media outlets and demonstrate that 2023 is no different:
‘2023 could be a very good year for renewables.’ – Forbes advisor[1]
‘U.S. stocks have long dominated investor allocations, but it may be time to to consider selectively owning emerging markets (EM) stocks ’ – Morgan Stanley[2]
‘We see energy sector earnings easing from historically elevated levels yet holding up amid tight energy supply. Higher interest rates bode well for bank profitability. We like healthcare given appealing valuations and likely cashflow resilience during downturns’ – Blackrock[3]
‘Materials—especially metals—look even better than energy at the start of 2023, based on supportive valuations and this industry group’s past performance in periods of weaker manufacturing data.’ – Fidelity[4]
Predictions and forecasts are all well and good, but investors would be wise to tread carefully before positioning their portfolio to benefit from narratives like the above. Many convince themselves that they have spotted a pattern in past returns, or that somehow the past can be used to navigate an uncertain future. They are likely mistaken. As Warren Buffet eloquently puts it:
‘Forecasts usually tell us more about the forecaster than of the future.’
The chart below is sometimes known in the investment world as the ‘patchwork quilt’. This example focuses on annual equity returns in developed markets since 2002, each country of the global developed equity market is represented by a different colour. The randomness of markets is well demonstrated. In 2005 and 2016, Canada came out on top whilst Ireland and Denmark were rock bottom, however, in 2015 Denmark was top delivering a 37.5%.
Figure 1: Equity Returns of Developed Markets (2002-2021)
Source: Dimensional Fund Advisers.
The same can be said for sectors, for example, technology. For the first 9-years of the last decade the technology sector beat the overall developed market every single year and came in the top three 2/3rds of the time. Last year, the streak came to an abrupt halt as technology fared relatively poorly. The energy sector, on the other hand, reaped the benefits of the surging post-pandemic demand for oil and gas, exacerbated by supply shocks caused by Russia’s invasion of Ukraine.
The temptation to chop and change is strong. Over the last 4-years, a portfolio invested in a technology index fund at the start of 2019 and switched to an energy one in 2021 would have enjoyed outstanding average returns. Whilst this would have been superb, it represents a classic case of investing using the rearview mirror. Hindsight is bliss.
The challenge that all investors face is that forecasting investment returns based on the information we have today is a highly challenging game to win consistently over the long term. If markets work, then prices effectively reflect an equilibrium position between the views of buyers and sellers and their expectations for the future. Unexpected shocks, such as pandemics, wars, financial crises, and political turbulence are quickly factored into expectations, and prices adjust accordingly. Very few individuals possess the skill (or fortune) to anticipate such events and reposition their portfolio appropriately.
Take it from the late, great John Bogle:
‘We deceive ourselves when we believe that past stock market return patterns provide the bounds by which we can predict the future.’
This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person. Your capital is at risk when investing. Past performance is not a reliable indicator of future results and forecasts are not a reliable indicator of future performance.
[1] Forbes advisor (2023) Top 9 Investing Trends For 2023. https://www.forbes.com/advisor/investing/top-investing-trends-2023/
[2] Morgan Stanley (2023) Investing in 2023: A Year to Be Patient and Selective. https://www.morganstanley.com/ideas/investment-outlook-2023-year-patient-selective
[3] Blackrock (2023) Global Outlook. https://www.blackrock.com/corporate/literature/whitepaper/bii-global-outlook-2023.pdf
[4] Fidelity (2023) 5 surprising investing ideas for 2023. https://www.fidelity.com/learning-center/trading-investing/five-ideas-for-newyear