Where are stocks headed tomorrow? The answer is no one knows.
It’s impossible to predict the future of the market.
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.
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. (Except, 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 Management 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.
In 2020, 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 of 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.
The biggest risks are the ones you can’t see coming.
And the time to prepare for them is now.
Good investing,
Alex