I bumped into an old friend the other day. And he asked me an earnest question.
“My guy says 2021 is going to be another good year for the stock market. What do you think?”
I didn’t tell him what I really thought, which is he ought to find another “guy” or gal.
There are plenty of experts who can tell you what the market has done. There are no experts who can tell you what the market will do.
Consider last January…
How many analysts and financial advisors predicted a worldwide pandemic, a health crisis, an economic lockdown, a precipitous bear market, unprecedented new monetary and fiscal policies, lifesaving new vaccines in a matter of months, trillions of dollars in new federal debt, and a slingshot recovery in stocks?
Yes, 2020 was an extraordinary year. But analysts, experts and other soothsayers aren’t any better at predicting the more ordinary ones.
What the economy and market do in the months ahead will depend on developments that we can’t possibly know now.
The conventional wisdom is that as more people get vaccinated and the pandemic recedes, consumers will make up for lost time and get out and dine, travel, shop and spend.
Combine that with cheap energy, rock-bottom interest rates and Washington’s latest relief package, and you have a strong case for a new economic boom in 2021 with possible GDP growth of 5%.
That scenario isn’t unlikely. The problem is that it is already discounted in share prices.
Most investors were surprised that the stock market could be so good in 2020 while the economy was so bad.
They may be equally shocked to see the market stumble as the economy gets better.
(Or the economic recovery – for any of several reasons – could turn out to be less rosy than expected.)
Then again, 2021 could be another excellent year for the market.
As I’ve tried to make clear, no one knows what the market will do in the short term.
What it will do over the long haul is far more predictable.
No other asset class can match the long-term performance of a diversified portfolio of common stocks.
(Or, better still, a portfolio of uncommonly good stocks.)
But there are bound to be bumps along the way.
So follow the advice of J.B.S. Haldane and make sure your portfolio is the “right size.”
Haldane was a scientist who specialized in physiology, genetics, mathematics and evolutionary biology.
In an essay titled “On Being the Right Size,” he wrote:
You can drop a mouse down a thousand-yard mine shaft; and, on arriving at the bottom, it gets a slight shock and walks away, provided that the ground is fairly soft. A rat is killed, a man is broken, a horse splashes.
A sudden market drop feels like a fall down a thousand-yard mine shaft.
And since corrections and bear markets can’t be accurately predicted, you have to prepare for them in advance.
By diversifying within the stock market, including real estate investment trusts and gold shares.
And by diversifying outside the stock market with high-grade bonds, high-yield bonds and inflation-protected Treasurys.
This ensures that your portfolio is “the right size” if the market hits an air pocket.
Investors with the wrong size portfolio – heavy on call options or margin debt, for example – may find that, like Haldane’s horse, their portfolio and net worth go splat.