Brad here. One of the things we try to do as investors is see into the future. To some extent, we can—but not as much as we wish and often not as far as we think. In today’s post, Brian Glazer, a senior investment consultant here at Commonwealth, takes a look at how to keep those expectations under control.
You’ve likely heard that “predictions are like opinions, everyone has one.” (Okay, maybe that's not the exact phrase, but you get the point!) Throughout history, people have been trying to predict future events—from Nostradamus, to Stephen Hawking, to Miss Cleo. In today’s world, forecasting is most prevalent for the weather, sporting events, and the stock market. But if you have ever been caught in a rainstorm during a round of golf despite your local meteorologist predicting “a gorgeous day without a cloud in the sky,” you know firsthand that forecasting is not an exact science.
Indeed, long-term forecasting is understandably more difficult than short-term forecasting, as there is more time for the myriad of variables that affect the markets to change, as well as to emerge.
Fear of the unknown
It is a scientific fact that humans fear the unknown. It follows, then, that the markets also hate the uncertainty that comes from the unknown. To gain (in the words of Janet Jackson) “control,” investors will read different analyst opinions about the future of the overall market, as well as specific areas of the market. It's natural to feel more in control if you feel at least some certainty about things. But investing involves risk because the future is so uncertain. The key, then, is to intently focus much more on the now than on the then.
The crystal ball does not see all
"You’ve got to be very careful if you don’t know where you are going, because you might not get there.”
— Yogi Berra (oft-quoted New York Yankees catcher)
Looking too far into the future has gotten some investors into trouble in the not-too-distant past. A good example is the 2016 presidential election. Analysts and investors alike made predictions at the beginning of 2016. Generally, it was anticipated that if Donald Trump—known for his unpredictable nature and his antitrade rhetoric—won, we would see a drop in the markets of 8 percent to 10 percent. On the other hand, a Hillary Clinton victory (which was widely expected) was already priced into the market, so most thought the markets would move sideways. What actually happened? The markets rallied and have continued to do so since.
Robert Frost was right!
“Two roads diverged in a wood and I—I took the one less traveled by, and that has made all the difference.”
— Robert Frost (“The Road Not Taken”)
A lot of investors look too far into the future. Instead, we would be wise to consider the road less traveled. In other words, evaluate current factors on a shorter-term basis, just as Brad does here in his Monthly Market Risk Update. Forecasting in the short-term is more precise than doing so for the long term; moreover, it is more of an evaluation than a forecast as you at look current data and compare it with historical levels. For instance, you could compare current Shiller P/E ratios with historical ones to evaluate valuation risk in the market.
The trend is your friend
“No, I don’t know where I’m goin’. But I sure know where I’ve been.”
— “Here I Go Again” (a song by Whitesnake)
The economy is usually either growing or slowing. Economic data points help determine which direction is trending. What other data points should you look at to gauge the current state of the markets? There are a many to choose from, but I have picked a few that I find to be the most useful:
- Economic growth as measured by GDP. This metric measures the value of economic activity within a country. If it beats economic forecasts, it is good for the stock market (and vice versa).
- Retail sales and consumer confidence. The consumer makes up almost two-thirds of GDP. So, if the consumer is strong, the economy is as well.
- Earnings growth. Are companies making more money than in the previous quarter? Back in my Fidelity trading days, one of its star portfolio managers, William Danoff, would talk about finding companies that were industry leaders and growing their earnings. In his opinion, these companies would provide solid returns, no matter what the overall market was doing.
- Which way the 10-year U.S. Treasury yield is moving. If the yield is trending higher, bond prices are going down and, more than likely, equity prices are going up.
- Relative strength of the U.S. dollar. Is the dollar getting stronger or weaker relative to other countries’ currencies? A stronger dollar makes imports cheaper and exports pricier. Moreover, commodity and international stocks perform relatively worse in this environment.
The path to financial success
Trying to time the market based on what you think will happen in the future—never mind just in general—can lower investor returns relative to market returns. Instead, you might think about investing for the long term, according to your risk tolerance and investment goals. In my mind, that is the more likely path to financial success.