by Scott Ronalds

If you’ve followed our writing, you know we don’t make short-term market forecasts. They’re not worth the paper they’re written on. We understand, however, that investors are concerned about what could play out in the world over the next 12 months and how it could impact their portfolios.

We thought it would be helpful to lay out a best case and worst case scenario that could lead to double-digit gains or losses for a balanced portfolio (e.g. our Founders Fund) over the next year.

Best case

For the capital markets to climb appreciably higher, there could be any number of triggers, including:

  • A boost to corporate profits. This could come from a number of sources, such as stronger than expected economic growth, a cut to corporate taxes in the U.S., and businesses repatriating foreign cash reserves.
  • A significant deployment of the large amounts of cash that investors are sitting on into stocks.
  • An increase in price-to-earnings multiples (P/E’s) stemming from continued low interest rates and a rising appetite for risk among investors.
  • An increase in business confidence leading to greater spending and investment.

Worst case

As is always the case, any combination of events could spark a near-term pullback in the markets, including:

  • A deterioration in corporate earnings.
  • A major political event or terrorist attack.
  • A decrease in price-to-earnings multiples stemming from a faster-than-expected increase in interest rates or a new appreciation by investors of the risks associated with stocks.
  • A marked slowdown in Chinese growth or a mistake by policymakers leading to a grinding halt to growth in the emerging markets.

Again, we have no idea where the markets are headed in the short term. Our best estimate for 5-year stock market returns is 4-6% per year given our outlook for corporate fundamentals, valuations, and investor sentiment.

If you’re drawing income from your portfolio or anticipate any near-term spending needs, it may be a good time to raise some cash in your portfolio given the strong run over the past year.

If you’re investing for the next five years or longer, the best thing you can do is stay the course, lean on your strategic asset mix and not worry too much about what the next year might bring.