Prediction season is upon us
I’m glad I’m not a financial media pundit whose job requires making predictions on the outcomes of major world events.
In recent times, from the Brexit referendum, to the US presidential vote, to general elections in Australia, the Netherlands, France and the UK, the record of many media and market pundits, pollsters and self-appointed ‘gurus’ has not been particularly distinguished.
Time after time, emphatic and confident-sounding headlines about the likely outcome of these events, together with the likely market reaction, have proved incorrect. This wouldn’t matter so much, if many investors didn’t take these calls seriously.
On 19th April, The Times of London splashed with ‘Theresa May Set for Landslide in Snap Election - Brexit Voters to Desert Labour’. The story said “May’s Conservative Party was on course to win a majority of more than 100 seats in the June national election.”
As we now know, the Conservatives not only failed to increase their majority, they lost 13 seats and fell short of the majority required to govern in their own right. The opposition, the Labour Party, gained 32 seats despite much pre-poll analysis writing them off.
Around this time, The Economist magazine editorialised that in the event of such an inconclusive result, the pound sterling and UK equities would “surely” take a hit. Yet on the day after the poll, the FTSE-100 benchmark index ended 1% higher. The markets today are even higher than in April.
Think back to the US presidential election in 2016. Market analysts quoted by CNBC predicted dramatic falls (of up to 13%) in the US equity market if Trump defied the polls and pundits to win the election.
Of course, not only did Trump defy the polls and win, but equity markets took the news “in their stride” (as one newspaper reported). The S&P-500 quickly moved to a succession of record highs and by June 2017 was about 15% above its pre-election levels.
It’s tough to forecast the outcome of an event, but even if you get that right, there’s still no guarantee the market will react as you assume, given the huge number of inputs that drive prices every minute of every day.
So it’s worth asking that if market professionals find it hard to accurately and consistently predict the outcome of major events and the market reaction, why should anyone bother making investment decisions by second-guessing prices?
The fact is markets price news quickly. So if collective expectations of an event change, you would expect prices to reflect that almost instantly. While many people think they can outguess prices, the highly competitive nature of markets makes it extremely hard to do that consistently and without costs eating up any gain they might receive. The evidence reflects that, with most money managers struggling to match benchmarks over time.
So what can you do? An alternative approach is to assume prices in highly competitive markets are fair and that they contain information about expected returns. You can use the information in prices to form portfolios that are designed to deliver outperformance.
Through broad diversification and by maintaining a long-term focus on your goal, you can improve the reliability of outcomes so that one-off geopolitical events, economic news and stock-specific factors do not throw your plan off course.
The news will come and go, of course, but using an evidence-based approach that harnesses the power of the markets means you can avoid the headline blues.