Hall of Fame baseball manager Casey Stengel is reported to have said, “Never make predictions, especially if they’re about the future.”
Stengel’s quip helps us pose our question this month: let’s say you had a crystal ball – and assume for the purpose of this hypothetical it is a functional crystal ball – would knowing the outcome of key events before they actually occur help you predict the future direction of stock prices?
The answer would seem obvious… of course that knowledge should be useful. If you know what’s going to happen, the market’s response should logically follow from there.
But as it turns out, the real world is frequently far more complex than the projections and predictions of even the best-informed experts.
Think back to early November 2016, in the days and hours before Donald Trump was elected President; or to late 2019 and early 2020, when you first heard news stories about a mysterious virus emerging from China.
It’s surprising but true: advance knowledge of key events is often not a helpful forecaster of market movements – specifically, the future prices of stocks and bonds.
In a NY Times “Outlook” column dated Feb 27, 2022, Jeff Sommer writes,
“Global markets usually weaken as wars approach, strengthen long before wars end, and view human calamity with breathtaking indifference…The recent stock market has been afflicted by multiple troubles [in addition to the war in Ukraine]: fears of rising interest rates, sizzling inflation, and continuing supply chain bottlenecks.”
(PPA note: no mention of problems associated with the ongoing pandemic, now at two years and counting.)
So even assuming investors knew in advance that all these problems would continue, the month of March showed monthly gains over 3% for US stocks, making a meaningful reduction in the YTD 2022 declines.
It is therefore worth asking what benefit investors would have realized knowing the problems in advance.
Sommer writes that “long-term investors with well-diversified portfolios of stocks and high-quality bonds–whether held directly or through low-cost mutual funds and exchange-traded funds (ETFs)–will probably be likely to ride out this crisis as they have so many others.”
Sommer also makes a case for owning bonds, even if their prices decline during certain time periods as interest rates rise, as a “buffer against major stock downturns.”
Another more recent article, with a similar point of view, appeared in The Economist magazine:
“A lot of bad stuff is happening just now, most notably a war in Europe, but also inflation and growing fears of recession.”
(PPA note: these recession fears are based on the Federal Reserve raising the short-term rates it controls and thereby slowing the economy to try to contain inflation.)
“Stocks are surprisingly buoyant, with the S&P 500 only 7% below its all-time high around the end of 2021… There are lots of plausible explanations for the resilience of stocks, one is that there is no good alternative to owning them… Ten-year yields are still below the rate of inflation… stocks may offer some protection against inflation if companies can raise their prices… Underlying all these rationalizations is a sense that equity investors do not quite believe the Fed will follow through on all the interest rate increases the bond market is pricing in.”
Here again we ask how investors are well served, even if they were correct in their knowledge of the outcome of current problems, since stock prices are “surprisingly buoyant.”
Just to show that there are also many times when knowing the outcome of future events would indeed be helpful in ascertaining future market direction, look no further than bond prices in March.
Since the rate of inflation did continue to rise in March, and the Federal Reserve did begin to raise its short-term interest rates, bond prices did in fact fall.
A few points to the bond pricing decline are worth noting:
1) While overall inflation went above 8 percent, “core” inflation, which excludes highly volatile food and energy prices, rose less than one percent.
Even though inflation definitely affects food and energy, which are important daily expenses for consumers, various financial institutions, including the Federal Reserve, do pay attention to the “core” rate as well.
A key question to answer now is whether a few more inflation readings like the one in March may result in a decline in the ten-year Treasury yield and an increase in bond prices, because the Fed may see less need to aggressively raise the short-term interest rates it controls.
(Note that longer-term rates, like that of the ten-year Treasury, are set and reset each day by the buying and selling of bonds in the marketplace, not by the Fed.)
2) The extent of bond price declines is typically measured by the amount and pace of the interest rate increases.
In this current environment of unusually large bond price declines, the anticipated quarter point Fed rate increases would likely not produce these kinds of price declines unless the market believed that the pace of these rate increases would be unusually rapid.
If the actual future pace of rate increases is slower than currently anticipated, it may well be that current prices are as high as they will get in this period.
3) History indicates that at some point in a market cycle, interest rates stop rising and bond prices stop declining.
Bond investors then receive the benefit of the higher interest rate payments associated with the bonds they own, thereby offsetting the price declines over time.
Long-term investing has two basic principles:
1) As Casey Stengel recognized, the future is inherently unknowable. Analysts and pundits and gurus may pore over their assorted crystal balls to accomplish this task, but it simply cannot be done.
2) Trying to time the direction of market prices is very difficult to do with any degree of consistency – even when you know the outcome of events before they happen. Market timing is defined as the effort to be in the markets when prices are rising, and to be out of the markets in advance of serious declines.
If the future is unknowable, and guessing at the market’s price movements is unlikely to succeed, what is left for investors to do?
Stay focused on your asset allocation and time horizon, be in touch with your advisor if you have any questions, and leave the crystal ball where it is.