Predicting the Future is Impossible

See the full episode notes HERE

In the most recent episode of AWM Insights, Brandon, Erik, and Justin discuss the first couple weeks of 2021 and what you should know.

Why is the market ignoring this extraordinary news event?

As we have seen over the last year not all news is treated equal by the market. The key to understanding the fluctuations of the stock market is that only new information that affects future earnings of public companies will move the market as a whole:

“The stock market is really devoid of emotion and is forward-looking, sometimes that can result in heightened volatility, as we saw in March of 2020, because of the COVID lockdowns and fast forward to the first week of 2021 where rioters were storming the Capitol and markets just stretched higher.”

The contrast of these two events that Justin is talking about here is that one of these events greatly affected the earnings of thousands of companies each publicly listed. The heavy uncertainty about how long the lockdowns would impact the world economy also contributed to the swift move lower in March. The coronavirus caused investors to demand a higher risk premium due to this uncertainty. The Capital riots was a local event that was over so quickly that there was no threat to the earnings of public companies. If there had been a real sustained threat to the future economy, then the market would have begun incorporating that into prices.

Know your history: Markets can go down too

Fear of missing out, or FOMO as it’s known, can contribute to investor amnesia where people forget that markets can go down. The US stock market has had long periods of time, when after adjusting for inflation, it took 15 years to recover. This prolonged adversity was during the Great Depression and the crushing inflation of the 70s. There have also been many periods of acute distress that resulted in shorter-term drawdowns of -79%, -49%, -37%, -36%, -39%, -52%, -31%, -48%, -51% and the extraordinarily high unemployment that went along with that economic pain.

“The hard thing about when we see markets going forward and having positive returns is it feels easy.” Erik is talking here about the euphoria and emotional bias that every investor has when the market is doing well. It can be easy to say that a company was a “sure thing” but this is just hindsight bias in action.  

Can you predict the future?

When I first started investing, I thought to myself “I’m pretty smart, I should be able to beat the market.” I’m grateful for lessons learned but even more grateful that it led me down the path to get my finance degree. I didn’t know what I didn’t know until I put in the time and gained some knowledge. The quote from Brandon couldn’t be any more accurate and I am thankful I learned it early in life:

“And we're not trying to predict markets because the more and more time that we've been in this business - that I've been in this business - I think, I've become more and more confident of one thing and that's my lack of ability to predict. And I think it takes some humility and maturity to get there early in your career, or early in investment career, whether you're an investor or you're somebody that's giving investment advice. I think you're always so tricked into, hey, my value is I'm going to predict the future. I'm going to determine which way Apple is going to go up or down, or which way the US stock market's going to go up or down, or I'm going to pick NIO, the next hot competitor to Tesla. And then you take a step back and you see what the pros have done over time. And the pros take that long-term approach.

So that was one thing I was thankful for watching all this unfold this week is thankfully we weren't trying to predict what was going to happen with the investment markets… I think as you mature in this business and you look at the evidence that's out there. Picking individual equities just doesn't make a whole lot of sense. I mean, you've got teams of people that are far smarter than us that spend all their time doing this. And all the evidence shows that it can't be supported, or it can't be repeated. It doesn't persevere over time. And so, there's some hype around say a Tesla. I get the allure of it, but I think this is just going back to the gambling fallacy. You see something like that, you don't want to miss out.”

I was definitely tricked by the financial media into the stock-picking game. I even had strong multi-year performance but eventually I had to admit I was just lucky rather than good. Once I realized I was playing the wrong game I could learn how wealth is actually built. Becoming a long-term investor and relying on high confidence sources of return to build wealth doesn’t sell very well but it definitely wins games.  

Don’t be fooled by the promises of unrealistic returns

“Let's not forget what generates the best returns in your lifetime, it's your human capital. It's your ability to go out and earn money and save it. So, if somebody is promising you certainly in the public markets that they're going to change your life, you probably need to listen to somebody else.”

Brandon speaks about what I think is the greatest failure of the financial services industry. Too many advisors are economically incentivized to sell you things that are either overpriced or not in your best interest. Many of these advisors have almost no finance expertise but they can tell a good story. Brandon also touches on the fact that you can have the greatest earning power in the world but if you spend every dime you make, you will never build any wealth. Erik explains it well:

“And that's where I love where we sit as advisors in the independent family office spaces. We've got nothing to sell you. We're not telling you these things because we're trying to convince you to invest in our proprietary products. We're sitting here saying, ‘You've worked so hard. You've articulated to us these are the priorities that you want to achieve.’ Now allow us, the pros, to be able to say, "Here's what the evidence is. Here's the best path forward for the most amount of success."

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Always ask questions about how an advisor is compensated and understand the good and bad with the incentives of any financial arrangement.