It’s that time of year again.
Endless predictions and price targets about where the markets are headed in 2022:
-The S&P 500 is going to ___.
-The 10-year treasury yield is going to ___.
-Crude Oil is going to ___.
-Bitcoin is going to ___.
There’s a huge audience for this type of content, but is there any value to it?
Only if you believe that pundits can accurately predict the future, and their track record on that front is not particularly good. This year serves as yet another example…
The S&P 500 has hit 65 all-time highs in 2021 and is up over 25% on the year.
At the end of 2020, how many leading pundits predicted these gains?
Exactly none. Among major wall street institutions, the highest price target of 4,400 is 300 points lower than where the S&P 500 is trading today (4,700).
Stocks haven’t been the only surprise this year. Oil is above $80 a barrel after going negative last year, Bitcoin has more than doubled after quadrupling last year, and U.S. inflation is at its highest levels in 30 years.
None of these things were widely expected or predicable at the start of the year. And yet here we are today, showing the futility of the prediction business once again.
But if you can’t predict the future, how can you invest? Don’t you need to know what’s going to happen next?
It might seem counterintuitive, but no. In fact, admitting that you don’t know where the markets are going is often the best thing you can do as investor.
Because it will lead you to diversify your portfolio and prepare it for the many possible outcomes that may arise.
What are some of those potential outcomes that might come as a surprise to market participants? I can think of a few today that stand out…
1) US Equities Underperforming
U.S. equities have been besting their global counterparts for over a decade, and by a wide margin. With endless fiscal stimulus and an ultra-easy Fed, it’s hard to envision a scenario in which this doesn’t continue.
2) Growth Underperforming Value
Growth has been outperforming Value for over a decade. The largest and most admired companies today are all in the growth category: Apple, Amazon, Google, and Microsoft. It’s hard to envision a scenario in which these stocks don’t continue their domination.
3) Reaching for Yield is Punished
Junk bond yields fell to all-time lows in 2021, moving below 4% for the first time ever. Defaults are low, the economy is booming, and at the first sign of trouble the Fed is expected to step in save the day as they did in 2020. With 0% rates still in effect, it’s hard to envision a scenario in which reaching for yield isn’t rewarded.
4) Large Caps Underperform
Large caps trounced smaller companies over the past decade, making it difficult to envision a change in leadership going forward.
5) Higher Inflation Isn’t Transitory
Over the last 20 years, U.S. core inflation has averaged 2% per year, with little variation from year to year. Both the Federal Reserve and the Federal Government are saying this year’s increase to over 4% is transitory and will come right back down to 2%. We haven’t seen a sustained level of higher inflation in a long time, making it hard to envision a scenario in which that occurs.
If we knew that the next ten years would look exactly like the last ten, we could safely ignore these possible scenarios and concentrate our portfolios in large cap U.S. growth equities and risky debt with no exposure to asset classes that might benefit from higher inflation. There are undoubtedly many that are doing just that as recency bias is a powerful force.
But for those who are students of market history and the many twists and turns that have occurred, a more grounded approach is warranted. That means holding assets that are currently loathed like emerging markets or value stocks, resisting the urge to reach for yield, and insulating your portfolio from the possibility of sustained higher inflation.
You do these things not because you know that it will serve you well, but on the off chance that it might. This is risk management in its simplest form: having the humility to admit that you don’t know the future and investing accordingly.
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.