I always like to start a new year reflecting on the last, especially taking stock of the lessons I learned. The article below unpacks three reminders that stood out to me in 2023 from a market and investing perspective:
- Short-term predictions add little value
- Returns are often earned in a short amount of time
- Volatility is a bad indicator of risk
- Short-term predictions add little value
Investors came into 2023 on high alert for a potential recession and scars from 2022’s brutal sell off in both bond and equity markets. At the end of 2022, The Financial Times published an article1 that stated that 85% of economists predicted that there would be some form of recession in 2023. The recession hasn’t materialized, and the US economy continues to show resilience. The more interesting prediction came from Wall Street strategists who predicted the first negative year in stock markets since the 2000’s (Exhibit 1 below).
These types of predictions are often off by a wide margin and the only value in market strategist forecasts is that they show the wide dispersion of outcomes that are possible. Investors are best served following Warren Buffett’s advice on forecasts: “We have long felt that the only value of stock forecasters is to make fortunetellers look good.”
It is very hard (or rather, impossible) to accurately predict what will happen on the macro side and how markets will react based on that.
Nervous investors who decided to hide in cash because most economists were predicting a recession and Wall Street predicted a negative year for stock markets, would have missed out on roughly 10%2 (in USD terms) from a return perspective in 2023.
- Returns are often earned in a short amount of time
Historical evidence demonstrates that returns are often earned in a short amount of time. As illustrated below (in Exhibits 2 and 3) over the 88 years from 1936 through 2023, the S&P 500 returned 10.65% (annualized). If we were to remove the returns of the highest-returning 88 months, the return of the remaining 968 months would be virtually zero. The remaining 986 months provided an average annual return of -0.26%. The best 88 months (just 8.3% of the months) provided an average annual return of more than 100% of the annualized return over the full period.
This lesson goes hand in hand with the reminder that time in the market is superior to timing the market, to remain invested through the good and the bad times and that investors should avoid the temptation of chasing performance.
- Volatility is a bad indicator of risk
Today, stock market volatility is extremely low. As shown by Exhibit 4 below, volatility is at pre pandemic levels. Does that mean that there is less risk in the market than at the height of the Covid sell-off? Most certainly not.
Investment risk is often counterintuitive and appears contrary to market perception. For example, often when an asset’s price decreases, most investors assume it’s a riskier investment, which actually makes it less risky. The opposite is also true. Volatility normally increases as the market becomes fearful and this normally coincides with valuations falling.
Today volatility is low, coupled with valuations that are trading well above long-term averages (particularly in the US market and its large technology companies).
Many factors could be influencing the market’s relative calmness at the moment. Inflation has moderated somewhat, with labour market strength also playing a key role. The unemployment rate hovers near five-decade lows and wage growth remains above historical averages. Despite aggressive interest rate hikes last year, consumer spending remains strong. Some may argue that investors are complacent as economic data could be weakening, but so far, the resilience of the economy is supporting lower market volatility.
Today the list of known risks is daunting. Upcoming elections globally and locally, a potential resurgence in inflation, US debt, a collapse in the Chinese economy, geopolitical issues, a weak Rand, loadshedding, trade wars, and the list goes on…Even though the collection of concerns is frightening it’s worth remembering that not every risk requires a whole new portfolio to survive its possible realisation. A well-constructed and diversified portfolio should weather external shocks fairly well.
Remember that there are always more things that can go wrong than what will go wrong and, in the words of Carl Richards, “risk is what is left after you think you have thought of everything”. So, bottom line – volatility is not an accurate indicator of risk.
In conclusion
- Don’t be tempted by short-term forecasts, they rarely work out as predicted.
- Returns don’t happen linearly and for successful long-term wealth creation you must remain invested.
- Risk is very counterintuitive. It’s often the opposite of what the market tells you. Risk is often deceptive and hidden – the riskiness of an investment is only tested in a negative environment. As Warren Buffett once said, “Only when the tide goes out do you discover who’s been swimming naked”. Think of risk as what you don’t know.
Trying to chase performance can be extremely harmful to an investor’s returns over the long term. It’s rare (if not impossible), even for professionals, to consistently time investments in and out of the market over time. In addition, one needs to consider the costs of trading funds, which is likely to only make matters worse.
A well-diversified portfolio that is designed to meet your investment goals whilst remaining within your risk tolerance is a far better solution, and much likelier to result in long-term investment success than trying to buy yesterday’s winners.
