Are investment forecasts valid? Dr Benjamin Holdsworth on how to avoid predicting the unpredictable.
Each year, investors face a barrage of commentary and speculation from the financial press about which stock, sector or country is set to do well in the coming months.
The quotes below are taken from articles published by well-known media outlets in recent weeks and demonstrate that 2023 is no different:
‘2023 could be a very good year for renewables’
‘US stocks have long dominated investor allocations, but it may be time to consider selectively owning emerging markets (EM) stocks’
‘We see energy sector earnings easing from historically elevated levels yet holding up amid tight energy supply. Higher interest rates bode well for bank profitability. We like healthcare, given appealing valuations and likely cash flow resilience during downturns’
‘Materials – especially metals – look even better than energy at the start of 2023, based on supportive valuations and this industry group’s past performance in periods of weaker manufacturing data’
Predictions and forecasts are all well and good, but investors would be wise to tread carefully before positioning their portfolio to benefit from narratives like the above.
Many convince themselves that they have spotted a pattern in past returns or that somehow the past can be used to navigate an uncertain future. They are likely mistaken.
As Warren Buffet eloquently puts it: ‘Forecasts usually tell us more about the forecaster than of the future.’
Data covering each sector of the global developed equity markets in the last decade shows us the randomness of performance.
For example, in 2014 and 2015, healthcare came out on top while energy stocks were rock bottom. However, in 2016 the roles reversed, with energy delivering a 40% premium over and above healthcare stocks.
Another topical example is that of technology. For the first nine years of the last decade, the tech sector beat the overall developed market every single year and came in the top three, two-thirds of the time.
Last year, the streak came to an abrupt halt as technology fared relatively poorly.
The energy sector, on the other hand, reaped the benefits of the surging post-pandemic demand for oil and gas, exacerbated by supply shocks caused by Russia’s invasion of Ukraine.
The temptation to chop and change is strong. Over the last four years, a portfolio invested in a technology index fund at the start of 2019 and switched to an energy one in 2021 would have enjoyed outstanding average returns of around 46% per year.
While this would have been superb, it represents a classic case of investing using the rear view mirror. Hindsight is bliss.
The challenge that all investors face is that forecasting investment returns based on the information we have today is a highly challenging game to win consistently over the long term.
If markets work, then prices effectively reflect an equilibrium position between the views of buyers and sellers and their expectations for the future.
Unexpected shocks, such as pandemics, wars, financial crises and political turbulence are quickly factored into expectations, and prices adjust accordingly. Very few individuals possess the skill – or fortune – to anticipate such events and reposition their portfolio appropriately.
Evidence from data and research firm Morningstar’s database of global developed equities managers confirms this.
Of the 5,269 active funds available at the start of 2013, 3,242 (62%) failed to survive the period, 1,841 (35%) survived the period but were beaten by the broad developed market, and a mere 186 (4%) survived the period and outperformed.
Take it from the late, great John Bogle:‘We deceive ourselves when we believe that past stock market return patterns provide the bounds by which we can predict the future.’
Dr Benjamin Holdsworth (right) is a director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
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