This article was first published in the National Post on July 21, 2023. It is being republished with permission.
by Tom Bradley
Speculating about something can be entertaining. Debating how the Jays will do, or the number of goals Connor McDavid will score, is fun and totally harmless. Everyone knows there’s no way of determining what will happen. Any outcome is possible.
The investment industry’s preoccupation with predicting the stock market is another matter. The people making the forecasts actually believe what they’re saying. Their seemingly well-reasoned projections also have entertainment value but, unfortunately, lead to poor investment decisions.
In my last column, I said that nobody can predict, with any precision or consistency, what the stock market will do in the next few months or years. Let me explain why.
The main reason is that stock prices are impacted by a multitude of factors, involving millions of participants. A few market forces are in the spotlight at any one time (i.e., inflation, growing demand for copper, aging baby boomers), but most stay in the shadows, only appearing on the radar after they’ve already had their effect.
Not only do overlooked factors reappear unexpectedly, but new ones emerge for which there’s no historical context, such as Brexit, COVID and ChatGPT.
And, of course, none of these factors move in isolation. For every action there’s a reaction that is equally hard to predict.
You get the picture. The reasoning behind a market forecast can be quickly overwhelmed by something that wasn’t contemplated or even known.
And then there’s the perilous connection between the economy and stock prices. I say perilous because the linkage is predictable only in its unpredictability. Investor emotions and changing expectations can take valuations from gloomy lows to euphoric highs, and all points in between. Indeed, stocks are volatile, not because of changing fundamentals, but rather the price investors are willing to pay for those fundamentals.
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The Financial Times’ Robert Armstrong said it well: “You try to understand markets as best you can, but you are surprised every day. Any intelligent and conscientious person who spends time in markets is humbled by how complex they are and how unpredictable they are.”
Yogi Berra put it more simply: “It’s tough to make predictions, especially about the future.”
Most commentators and strategists use economic data as a starting point for their market calls. It sounds logical but, while extrapolating current growth and inflation trends into the next year works most of the time, it doesn’t help investors make money. As I noted earlier, the linkage between the economy and stock prices is sloppy at best. Some of the best market runs occurred during periods of slow growth, and conversely, there have been severe corrections when the economic outlook was strong.
Anticipating a change of trend can be extremely rewarding but, you guessed it, it’s hard to do, and rarely is the timing accurate enough to be useful.
Listening to a big thinker justify their market call can be intoxicating. You want to believe they have a crystal ball, and the media can usually oblige by finding someone who got the call right (it doesn’t seem to matter if they’d been predicting it for 10 years, or that the prescience came after a series of miscalculations).
Why do I obsess about the forecasting fallacy? Because it reduces investor returns. It creates needless trading activity and prompts investors to deviate from their long-term plans, all in hopes of catching a market upturn or avoiding a downturn.
Investing isn’t about timing the market but rather time in the market. Look at any long-term stock market chart and you’ll see that it trends up and to the right, with lots of zigs and zags along the way. The more time you can ride the wave, the better off you’ll be.
When people ask me about the stock market, I tell them it’s like a bad girlfriend or boyfriend. Unpredictable, overly dramatic, irrational at times and totally insensitive to your needs.
That’s not something I want to bet my financial future on. I’ll stick to my much more reliable and diversified long-term plan.