The problem with market forecasting
Last year defied many expectations. Recessions were predicted in several key economies but never materialised, and what many people thought would be a lacklustre year for investors turned out to be rather good. After posting double-digit losses in 2022, stocks soared and bonds rebounded.
Realised market returns are driven by the difference between investor expectations and the events that actually transpire. If reality pans out better than expected, markets may deliver strong returns along the way. On the other hand, market returns may be disappointing if developments are worse than anticipated.
The most recognised global index of shares returned 21.6% in 2023.
That’s three times its annualised compound return since June 1994.
Such an outsized return suggests investors’ expectations for 2023 were exceeded.
Think about that for a moment: We’ve had major geopolitical conflicts, a US banking crisis, deteriorating fiscal health for many countries, a cost-of-living crisis, and yet, on balance, outcomes were better than markets expected at the start of the year.
This is something to keep in mind when reading forecasts for 2024. If predictions (good, bad, or indifferent) come to fruition, stocks should have a positive expected return.
The probability of a positive return from stocks increases over time
An investment in the US stock market grew wealth during 75% of the one-year periods between January 1926 and May 2023. Over ten-year periods, this occurred 95% of the time. While positive stock returns are never guaranteed over any horizon, no period exceeding 184 months (just over 15 years) has seen a negative return in the US.
As a financial planner I can help you build a robust portfolio, retire comfortably, and protect your loved ones from financial ruin. I can’t forecast political events, global crises, or medical breakthroughs. I’m also unable to see natural disasters around the corner.
It’s true that world events can have a short-term impact on markets, but the changes we see in our investment portfolios and pensions are largely dictated by the way humans respond to these world events, rather than the events themselves.
Investment opportunities exist all around the globe, but the randomness of global stock returns makes it exceedingly difficult to figure out which markets are likely to be outperformers. How should investors deal with this kind of uncertainty?
First, they should remember that it’s challenging, at best, to predict a country’s returns by looking at the past, as shown by the performance of global markets since 2003. I’d say impossible. In the past 20 years, annual returns in 22 developed markets varied widely from year to year. (Each colour represents a different country, and each column is sorted top down, from the highest-performing country to the lowest.)
Investors can benefit from understanding that they don’t need to predict which countries will deliver the best returns during the next quarter, next year, or next five years. Why? Holding equities from markets around the world — as opposed to those of a few countries or just one — positions investors to potentially capture higher returns where they appear, and outperformance in one market can help offset lower returns elsewhere. Put another way, a globally diversified portfolio can help provide more reliable outcomes over time.
You could spend a lifetime jumping from one asset class to another, looking for the perfect fit and never getting anywhere. The old adage is true: Time in the market is better than timing the market.
If you feel like selling your investments whenever they fall in value, congratulations, you’re human! But history shows us that markets do eventually rebound after downturns. This makes panic-selling counterintuitive, no matter how safe the decision may feel in the moment.
During times of instability, it can be helpful to have a financial planner at your side. When it all gets too much and you’re tempted to swap your stocks for savings, your planner can talk you down. You’ll be rewarded for staying the course.
Don’t burst your bubble
It’s human nature to crave certainty. When working with new clients in particular, they often expect me to know exactly what’ll happen. They assume I’ll make weekly changes to their portfolio based on market activity and insider knowledge.
A good financial planner will never change your portfolio or strategy based on market projections or forecasts. Instead, we’ll create comprehensive plans designed to help you meet your specific goals – whether that’s retiring at 40 or helping your children buy their first home.
Let’s focus on what’s going on inside your little bubble and ignore what’s happening outside. Do you have an emergency fund, well-funded pension, updated will and protection policies in place? If so, you’re doing well. You’re on track. Now, let’s talk about how we’ll fund that underground bunker…
Two examples help make the point well:
• New Zealand posted the highest developed markets return in 2019—but the lowest in 2021.
• The US ranked in the top five for annualised returns over the entire 20 years but finished first in the country rankings just once over that period. In nine calendar years, it was in the lower half of performers.