WHY STOCK MARKET FORECASTERS ARE IN NEED OF A REALITY CHECK
Advisers and economists are making baseless projections, Tom Bradley writes.
This is an intervention. It's for investment advisers and economists who have been exhibiting compulsive, addictive and destructive behaviours.
I think there are certain phrases I'm supposed to use for an intervention (I love you; I will be here for you; Thank you for all you've done for me) but I'll get right to it.
You are doing your clients a disservice and embarrassing yourself when you forecast what the stock market is going to do over the next month, year or even few years. You are implying that you know what's going to happen when in reality you have no clue. You may even be designing clients' strategies on these baseless predictions. And if nothing else, you're wasting valuable time and energy that could be used to find good companies to invest in or to provide advice to your clients.
I'll make my case using things you know to be true.
There are a multitude of factors that drive stock prices. Some are in plain view and many more are hidden. Some appear urgent but are unimportant, while the important ones are often ignored. For instance, elections in Ottawa and Washington have little impact on long-term returns while the growing middle class in Asia is a key economic force.
These factors interact in unpredictable ways, with each event leading to other possible events (every action causes a reaction).
Allow me to get into the weeds for a minute to reinforce this point. As you know, market indices represent a collection of companies. How these companies do depend on many things including quality of management, demand for the product, input prices, competitors, regulation, changing customer preferences and innovation.
Their profits also depend on macro factors like the strength of the economy, currency movements and the level of interest rates. Let's not forget, there are exogenous factors like weather events, terrorist attacks and wars.
You see what I mean? There's a lot that can affect each company's results and ultimately the market return. But that's not the hard part. Even if you get all that right, you then need to grapple with the linkage between the company's fundamentals and its stock price. As it turns out, what investors are willing to pay for profits, or a stock's valuation, is
highly elastic.
A company may have a historical valuation range, but at any given time its price-to-earnings multiple can be stretched or compressed based on, you guessed it, a multitude of factors. Things like how bullish or bearish investors are, and whether they're focused on growth, dividends or ESG.
For an example of how difficult predicting valuations is, you need look no further than the emerging growths stocks. A year ago, companies like Zoom Video Communications, Doordash and Affirm Holdings (buy now, pay later) were riding high based on market leadership and unlimited growth potential. Today, they're still cool companies, but their
stocks are down 60 to 80 per cent as growth is moderating and investors are looking for profits.
If you still don't accept what you're doing is futile, please listen to what some highly successful investment professionals have to say.
Doug Macdonald was a pioneer of advice-only financial planning in Canada. I'll never forget what he once said to me: “It became much easier to do our job once we realized that nobody, including us, knows what is going to happen in the future.”
No doubt you've heard of John Kenneth Galbraith. He put it another way: “We have two classes of forecaster: Those who don't know and those who don't know they don't know.”
And I challenge you to find an annual market forecast anywhere in Warren Buffett's writing. Indeed, he once said, “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.”
If none of this is getting through to you, please look at the numbers. From my experience, most market forecasts are in the range of six to nine per cent. In the last 60 years, the Canadian stock market has had an annual return in that range exactly five times. Yes, five out of 60. Meanwhile, it's been in negative territory 16 times and up over 20 per cent on 18 occasions.
So, I implore you (and your firm) to stop making useless market predictions. I know it will be difficult. If you're struggling with withdrawal, remember: I'm here for you.