Why the Market is Unpredictable
Going into 2021, there were lots of clouds on the investment horizon: Covid was raging and the vaccine was only just rolling out, many people were still out of work and yet the market did not reflect these woes.
Though one should never try to predict a market’s annual performance (for it’s too easy to be wrong), going into 2021 my expectations were modest at best. Instead, the S&P 500 roared up over 28% for 2021. Wow! Really?? Why?
It’s always difficult to pinpoint why the market does what it does over relatively short periods. My best guess (and it is a guess, which is true for all market predictions) is that the Fed’s very accommodating policies and the adding of huge amount of liquidity into the markets likely had a strong influence. With so much money sloshing around in the system, it had to find a home somewhere, and with interest rates scraping near zero, the stock market (as well the housing market) appeared to be a primary beneficiary.
What does this mean for 2022? As always, it’s fundamentally hard to say. At some point, the market will feel gravitational effects, but it’s anyone’s educated guess (again, guess) as to when.
For true long-term investors, this is not much of an issue as the market has historically gone up very nicely over the long run. However, the short run is often a flip of the coin as to whether the market will go up or down. A wise investor is ready for both short-term scenarios.
Not All Was Hot in the Market
Though the stock market had a strong 2021, many stocks, including many quality names such as Amazon, Starbucks, and Disney experienced more modest returns or even declines. There was more turmoil and upheaval than the indexes indicated. As a result, not only did this somewhat moderate the typical diversified investor’s portfolio returns, but it also suggests the stock market was not as bubbly overall as some of the indices depicted.
The ARK is Taking on Water
The Ark Innovation Fund, run by Cathie White and exemplifies the ‘new cyber economy’, aggressively bought headline investments such as Tesla, crypto and others. The fund more than doubled in 2020, Woods became a star and money poured in. What could go wrong?? Well, while the S&P 500 was up almost 30% in 2021, ARK Innovation was down 30%, and ARK is down a lot more than the market again as January ends.
How can this be? Oh, it be. I’m sure Cathie Woods is smart and impressive in her own way. However, this is just one more in a series of lessons of why ‘hot’ investments should generally be avoided and ‘hot’ managers should be recognized for what they are: not seers of the future but fortunate beneficiaries of hot trends that will cool off at some point. Don’t be the person who jumps in as things cool down – and you won’t know that until it’s too late.
The Forgotten Black Swan
A black swan is a very large event, often negative in consequence, that occurs without warning. After it happens, as is human nature, we try to theorize how we could have seen it coming instead of accepting that certain things just cannot be predicted.
The book Black Swan by Nassim Taleb discussed the idea of a black swan event and its relation to the stock market. In late 2008 and early 2009, the market nosedived due to fears of a broad financial collapse. This brought the concept of a black swan event to the front of the minds of many investors and sold many books for Taleb as a result.
Shocked by the market’s quick and dramatic fall, investors wanted to find ways to predict these troublesome market anomalies so they could be avoided in the future. Of course, there’s simply no way to accurately and consistently do that. The best defense against black swans is to factor in, to the degree one can, the ‘unknowable’ into your investment strategy equation ahead of time.
As the market has trended upward for quite a while now, investors can get complacent and not factor in things such as black swans, or simply markets trending downward again. Don’t let this happen to you. When you think of the future, be optimistic, but cautiously so. Some things require bold action but investing rarely does (except to perhaps step up and be willing to buy stocks when markets are in freefall). A steady, long-term approach to investing has shown to work well and is relatively simple (at least in theory), but is hard to execute for many investors and can result in bad, short-term decisions.
Be Aware of Your Surroundings
Investing, as with driving, requires one to be on the look-out for possible dangers as you move forward. As a driver, you have to regularly ask yourself questions such as ‘Is that car going to stop at the light?’ or ‘is that squirrel going to run into the road?’ and ‘does that driver in front of me see that I’m passing on the left?’. While factoring in the ‘typical’ dangers, it’s also worthwhile to know that there are certain things you cannot fully plan for but could still happen. Your tire could blow out or a deer could run in front of you. These are black swan type of events in the sense they cannot be predicted and could be catastrophic.
In the investment world, it’s healthy to factor in black swan events to manage expectations even though you cannot predict their occurrence. Don’t forget that a black swan can always happen and not blindly move forward without that awareness. Warren Buffett once stated, “You shouldn’t own stocks if a 50% decrease in their value in a short period of time would cause you acute distress”.
As they say: hope for the best but plan for the worst. I’d modify that to ‘factor in the worst, plan for something likely in the middle…and hope for best’. It’s not as catchy, but I think it fits a lot of life.
The simple wisdom of Warren Buffett can never be over-appreciated. As we move into a new year with new expectations, it’s not a bad idea to recall a couple of his quotes for wisdom and perspective:
- “If you’re in the luckiest 1% of humanity, you owe it to the rest of humanity to think about the other 99%”
- “What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know”