Jan 23, 2024
Are you a little surprised how well the stock market performed in 2023, especially with the rally in November and December that resulted in the S&P 500 being up +26.3% for the year? If we asked investors twelve months ago, it’s doubtful many would have been that optimistic considering how much uncertainty was on the horizon at the time (most of Wall Street was predicting a recession!).
Similar to how 2022 came as a surprise for many investors (remember the huge shift in interest rates?), 2023 continued the trend that one-year performance of market indexes is very difficult to forecast. In fact, we would argue that it is generally futile to try.
The truth is, much of the market sentiment right now hinges on the direction of interest rate changes – and if the Fed (who controls short-term rates) doesn’t know for sure what they are going to do, then how would the collective market do any better forecasting their decisions? And what about all the unknowns that are sure to surprise us (like geopolitical conflicts, election outcomes, natural disasters, etc.)? It’s not the risks that we know about that should worry us, it’s the “unknown-unknowns” that usually disrupts the markets.
There are too many variables to predict correctly. In fact, any accurate forecast would likely be due to just as much luck (if not more) than skill. A broken clock is still right twice a day. And most of Wall Street, (if you actually look) has had a terrible track record for one-year forecasts.
The bottom line is that we want investors to get out of the mindset of “what is the market going to do this year?” and think more about: “is my portfolio positioned well to play the appropriate amount of offense and defense AND successfully accomplish my financial goals over time, no matter if the market is up, down or sideways this coming year?”
If you are playing the game to win in short-term increments (like years, months, or heaven forbid, days), that feels like speculation and more akin to playing your odds in the casino. Certainly, some people can make money this way, but it’s risky. There are odds that you can win big, but also a chance that you can lose big.
Instead of betting on specific, difficult to predict outcomes, the strategy we continue to follow is buying quality businesses with a track record of success and a predictable pattern of cash flows that we expect to grow at a reasonable rate into future years – that would be the extent of our forecasting. Regardless of what the overall market does in the short-term, if the earnings of those businesses continue to increase during most years, then the value of your ownership interest will follow over time (see the chart on the next page).
Like passengers running from one side of the boat back to the other, the value of a stock can swing from underappreciated to overhyped, but assessing what the current sentiment is can be helpful in knowing when it’s a good time to buy more or when it is a good time to harvest some profits.
We know that the bumpiness of a portfolio owning only stocks is not for everyone – that is why layering in the appropriate amount of bonds is critical (which, as we said in our last quarterly letter, is an asset class that is now paying reasonable yields, with lower risk, for the first time in a while). The right amount of bonds in the mix is determined by each investor’s tolerance for risk and their short- and long-term cash flow needs. This is a great time to talk to your advisor to make sure your plan is up-to-date and you have the right asset allocation for your needs.