Reprinted courtesy of the National Post
by Tom Bradley
I recently found a crumpled piece of paper in my jacket pocket that said, “Embrace your ignorance.” I can’t remember where or when I heard the phrase, but I’ve taken up the cause since my discovery in hope of better assessing my own blind spots and weaknesses regarding investing.
I’m not going to confess my darkest secrets here, but re-reading the piece of paper reminded that I’m not the only one in the investment industry who fails to embrace his ignorance: My counterparts are often found to be supremely confident, able to answer all questions and never lost for a prediction.
Indeed, when I look at the industry through this unique lens, I see professionals who regularly defy all logic and evidence by explaining the unexplainable and predicting the unpredictable. Here are three examples.
Cause and effect
During my first week in the industry, Don Dillestone, one of the wily veterans in our research department, pulled me aside and said, “Tom, when you hear that the market went up for such and such reason, ignore it. Commentators like to find a cause for every effect, but it doesn’t work that way. All kinds of things move the market.”
He was referring to sound bites such as, “The market rallied on Boeing’s strong first quarter,” or, “The market went down today because of renewed trade concerns.” Over the past 18 months, U.S. President Donald Trump has been regularly credited for moving the market.
But Boeing, trade and Trump are just three of the many thousands of factors that impact stock prices, which, in turn, add up to the index number reported on the news. In reality, most days, we’re totally ignorant of what moved the market.
Economy and market
Investment professionals love to tie their market view to economic factors. We’re often hearing phrases such as, “The economy is strong, so stocks will keep rising.”
Evidence suggests, however, that the linkage between the two is somewhere between haphazard and non-existent.
Mr. Market isn’t reading today’s economic data and deciding where to go. He’s straining his eyes to read what will be in the news 12 to 18 months from now. The market is all about the future, not the past.
Growth, inflation and money supply can certainly impact capital markets over time, but there’s no evidence that an accurate prediction of these or other economic factors will lead to a useful market forecast.
Pontificating about the economy sounds brilliant and may dazzle some clients, but when it leads to a market call (with no mention of other factors such as valuation), it reveals quite the opposite.
Which brings me to the age-old question: What do you think about the market?
You often get the impression economists, market strategists and portfolio managers know where the market is going in the coming months. For instance, a portfolio manager on CNBC last week said, “We reduced our equity weighting at the end of the second quarter. We’re bracing ourselves for another five-to-eight-per-cent pullback in Q3.” I desperately wanted Becky, the show’s host, to ask him what he based that on.
Most market forecasts stay close to the historical averages, but next year’s return is almost assuredly not going to be that. I looked back 60 years and the average annual return of a blended equity portfolio (Canadian and foreign stocks) was 9.8 per cent per year. Over that period, there were only four calendar years where the return was between nine per cent and 11 per cent — four out of 60.
It’s not clear why my industry keeps trying to be precise about something that’s anything but.
The investment industry is full of brilliant people. Some know more about yield curves, inflation, productivity, capital flows and trading patterns than the rest of us could ever hope to. But where their brilliance betrays them is when they try to use that knowledge to predict the timing and magnitude of the next market move.
The next time your adviser or portfolio manager wants to make a change based on an economic view or market action, push the pause button. Ask about his long-term track record on such calls and if you get a soft answer, suggest he too embrace his ignorance.
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