The predictions for this year’s financial markets are out. Should you incorporate them into your investment portfolio?
The predictions for this year’s financial markets are out. Should you incorporate them into your investment portfolio?
The predictions for this year’s financial markets are out. Should you incorporate them into your investment portfolio?
Here’s what some of the experts had to say in 2020 when the COVID pandemic hit. The forecasts below were made by some of the most well regarded people in economics and money management. Names have been withheld in order to avoid further shame. To put the dates in context, stock markets peaked in mid-February 2020, and hit bottom on 23 March. From the next day they embarked on an epic run that continues to this day.
March 24, 2020 – With the COVID-19 pandemic still spiralling out of control, the best economic outcome that anyone can hope for is a recession deeper than that following the 2008 financial crisis.
March 25, 2020 – What the Fed is doing is extremely bearish for the US economy … it ensures that this recession, depression that we’re entering is going to be extremely brutal.
March 26, 2020 – I continue to expect the S&P500 to lose about two-thirds of its value over the coming years.
March 31, 2020 – The low we hit in March, I would bet that low will get taken out.
April 1, 2020 – We’re going to have the worst bear market of my lifetime.
April 23, 2020 – Many equity bulls think it is inevitable that massive central bank liquidity will boost equity prices. This strikes me as ludicrous.
May 12, 2020 – So even as the stock market is telling you that it is all figured out, I can assure you, what we face at this very moment is a highly uncertain economic future, and unfortunately, most of the longer-term risks are to the downside, not the upside. We are in a depression, not a recession.
Hindsight is a wonderful thing. As the pandemic spread globally, the economic outlook was so unclear, and so potentially dire, that negative predictions far outnumbered bullish ones. One of our large institutional investors wanted to liquidate all equities and move to cash, as they were heavily influenced by the assessment of the expert epidemiologists at Imperial College in London that the country would run out of hospital beds and more than 500,000 people would die if no government action was taken.
Bearish predictions are often well researched and intelligently argued. Bullish predictions on the other hand can be reduced to the most basic view that the world will sort everything out and that this too shall pass. Hardly encouraging in the midst of a crisis. At such times, I remind myself of one of the books I read early in my investing career called Triumph of the Optimists. The simplistic bullish predictions by the optimists are the ones that end up being correct at the end of the day.
Without the benefit of hindsight, how do we decide which forecasts to pay attention to? We are attracted to clear predictions like price targets as they suggest a direct unambiguous answer to what we should do. However clear predictions like the above often turn out to be spectacularly wrong, especially at market turning points when we need them the most. Not only are they wrong, they will mislead and cause you to make errors of judgment in your portfolio.
The 2022 average price prediction by Wall Street for the S&P500 is a gain of 8.2%. Add in dividends, and you get a prediction of just a touch below 10%, right in line with the long term average return of the US stock market. This forecast is useless. In any one year a return of 8-12% occurs only 9% of the time. This forecast has a 91% chance of being wrong.
At the opposite end of the spectrum we have the common economists’ reports along the lines of: “if Omicron turns out to be as mild as early indications suggest, and inflationary price pressures subside as the global supply chain bottlenecks normalise, equities will let out a sigh of relief and post another good year in performance. If however Omicron turns out to be more deadly, there is significant downside especially in the US given high valuations.”
Sounds eminently sensible, but dig deeper and all this says is that if nothing bad happens, equities will go up, but if something bad happens, they will not. You don’t need a PhD in economics to make such a statement.
Since no one has a crystal ball, and many experts can get it so wrong, the best predictions are the ones that come attached with probabilities. Attaching probabilities to predictions can seem like hedging your bets. A year later the forecaster can say that their 80% prediction didn’t come true, but this was because there was a 20% chance it would not!
Reading all the predictions for the coming year is a great exercise, but not to figure out where the markets will be, because no one knows. The aggregate predictions are useful to see where the strong market consensus views are, and then to do a next level analysis to judge where a consensus view is likely to have less than a 50% probability of occurring.
Below are three consensus views for 2022, where the probability of them being correct is likely to be less than 50/50:
Forecast 1: US equities average forecast of a 9-10% gain.
This is what Wall Street forecasts almost every year. We are currently at the top decile of historical valuations, a level where 10-year returns have averaged only 3% p.a. On top of this, the Fed will start hiking interest rates, an environment where on average equities have lost money in the short term at the rate of -4% p.a. It is impossible to forecast with any accuracy short term returns, but probabilities point to a lower return in the future than the historical average.
Forecast 2: China equities, particularly in the tech sector, are cheap.
The analysis on valuations is correct, but this is provided that the government relaxes its targeting of the tech sector. This is a politically motivated situation. Other than China’s paramount leader, no one has any idea when it will stop. It is difficult to envision a scenario in which the Chinese government would relax the new rules on the use of consumer data anytime soon, which all technology companies rely on to drive earnings.
Forecast 3: The death of the 60/40 portfolio.
The pundits making the case for the death of the 60% equity and 40% bond portfolio allocation, which has served investors well for forty years, is deafening. This prediction will be correct if interest rates rise significantly faster and further than expected. Last week’s release of the Fed minutes emboldened this view, with expectations of the first rate hike moving forward from June to March. For this prediction to come true, bonds would need to enter a secular bear market, which implies the disappearance of the Fed ‘put option’. It is instead more likely that at any hint of an economic slowdown the Fed will resume what it has done for the last two decades and pause or even reverse its rate hikes, giving the bond bull market more longevity.
When looking at any investment forecast, think of them in terms of probabilities, not clear outcomes.
By LEONARDO DRAGO
Co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund management services to endowments and family offices, and wealth-advisory services to accredited individual investors.