2020 has been a year for the books.
We’ve had a health emergency and an economic crisis.
We’ve had tremendous innovation – and adaptation – in the private sector and unprecedented policies and stimulus in the public sector.
We’ve experienced both the fastest bear market in history and the fastest bull market in history.
(Stocks are up more than 70% from the March 23 low.)
Who predicted all this… and where will stocks go from here?
The answers are nobody… and no one knows.
That may sound disappointing – or just plain odd – coming from someone who gives investment advice for a living.
After all, people in my line of work are supposed to have strong, well-reasoned opinions about the outlook for economic growth, inflation, interest rates, currency values, commodity prices and the market.
Yet those opinions are worth exactly what you pay to hear them: nothing.
Stocks are the best-performing asset class of all time – and that isn’t likely to change.
But whether stocks go up or down in the short to medium term will depend on events we can’t foresee.
Under Scenario A, for example, vaccines and social distancing could corral the pandemic. The economy could bounce back. Business could boom again. And corporate profits could shoot higher.
Under Scenario B, the pandemic could rage longer than expected. The economic bounce could be tepid – or temporary. Many businesses could struggle. And corporate profits could fail to meet expectations.
Confounding investors further, we could get Scenario A and stocks might sell off anyway.
(Corporate profits and share prices are not perfectly correlated, as this year’s market action amply demonstrates.)
Of course, we may see neither Scenario A nor B. We might get something entirely different that we can’t predict.
Indeed, that we can’t even imagine.
This happens more frequently than most investors realize.
Consider just a few of the biggest market-moving events of the last 35 years…
On Black Monday in October 1987, world stock markets crashed.
No government official was shot that day. No currency collapsed. In fact, there was no major news whatsoever.
Yet markets around the world plunged up to 40%… in a single session.
Who predicted this?
No one. (Excepting, of course, the broken clocks who predict a stock market crash every year.)
After a three-year recovery in stocks, we hit another bear market as the world geared up for the first Gulf War.
Who predicted that Iraqi President Saddam Hussein would suddenly invade Kuwait and grab its oil fields?
No one.
A few years later, the hedge fund Long-Term Capital lost $4.6 billion in four months.
Then-Federal Reserve Chairman Alan Greenspan had to recruit 14 major financial institutions to help supervise its orderly liquidation and avoid a financial panic.
Who predicted the collapse of a major hedge fund run by Nobel laureates?
No one.
On 9/11, a small group of terrorists flew planes full of people into buildings.
That caused the stock market to close for a week. It plummeted when it reopened.
Who predicted 9/11?
No one.
Real estate prices in the U.S. rose more or less steadily for almost a century.
But 13 years ago, prices suddenly accelerated. The housing market turned into a bubble, then burst, leading to a financial crisis, the Great Recession and, not incidentally, a halving of share prices.
Who saw all this coming?
No one.
This year a novel virus escaped China and became a global pandemic, leading to a health crisis, millions of business shutdowns and the biggest spike in unemployment since the Great Depression.
Who predicted this?
No one.
Knowing all this, do you really care what some talking head on CNBC forecasts for the year ahead?
While the timing is always uncertain, we will have many bull markets and bear markets in the future.
Smart investors prepare for them in advance.
How?
You capitalize on bull markets by owning a diversified selection of high-quality companies, with excellent prospects, that sell at reasonable valuations.
You prepare for bear markets by asset allocating outside of U.S. equities, position sizing your stock portfolio and running trailing stops behind your individual positions.
You may feel you have a good grasp on what’s happening with the economy, interest rates, inflation and even geopolitics.
That’s still not enough.
Risk isn’t limited to what you can imagine. It also includes what you can’t imagine.
Don’t get me wrong. I’m an optimist. I see human ingenuity, technology and capital markets creating a far better future. I remain a long-term believer in equities.
But for investors, the biggest risks are the ones you can’t see coming.
And the time to prepare for them is now.