Don’t let interest-rate predictions dictate your investment decisions

AT FIRST glance, it sounded like good news. Last Friday (Jan 10), the US labour department said that job growth surged in December, while the unemployment rate was lower than forecast. Curiously, the stock market wasn’t celebrating.

According to market watchers, a healthy economy could mean fewer interest-rate cuts on the horizon – and that’s not good news for Wall Street. The market reacted swiftly, plunging last Friday as investors grappled with the implications.

Sequences such as this suggest that interest-rate predictions can influence the stock market’s direction. Hence, it stands to reason that investors need to pay attention to forecasts or risk finding themselves on the losing end. At least, that’s what the market wants you to believe.

Wrong number, wrong timing, wrong size

Morgan Housel, author and partner at Collaborative Fund, once quipped that if you read last year’s market predictions, you will never take this year’s predictions seriously.

Let’s test his theory. A little over a year ago, the US Federal Reserve signalled its intention to cut interest rates three times in 2024. This commentary sparked a flurry of predictions, with market watchers vying to outguess the Fed on the number, timing, and size of these cuts. Goldman Sachs, for instance, boldly predicted five rate cuts.

We ended up with just three interest-rate cuts in 2024 – a significant miss, to say the least. If interest-rate predictions were a baseball game, this would be strike one for the forecasters.

Next, there was the matter of when the first interest-rate cut would happen in 2024. Traders thought there would be a 73 per cent chance of an interest-rate reduction in March. In reality, the first rate cut happened in only September, six months later.

Again, forecasters must have been bitterly disappointed with the outcome. That’s strike two.

What about the size of the interest-rate cuts? According to CNBC, the market priced in a 1.5 percentage point reduction in 2024 shortly after the Fed commentary. The final result was a single percentage point cut in 2024, a third lower than the forecast. If you have been keeping count, that’s strike three.

In essence, all three predictions, regarding the number, timing, and size of the cuts, were wildly off the mark. They were not even close.

If last Friday’s market reaction was any indication, 2024’s stock-market performance should have been terrible, with the year marked by one disappointment after another. Yet, as we now know, the opposite happened. The S&P 500 turned in one of its better annual performances last year, rising by more than 23 per cent.

Right prediction, wrong outcome

Did forecasters get anything right? Some did. According to the Visual Capitalist, four firms – Morgan Stanley, Bank of America, Citigroup and Nomura – pencilled in a one-percentage-point cut for 2024. Credit should be given where it’s due: their forecasts were right.

However, did getting these predictions right matter in the end? As it turns out, not so much.

Morgan Stanley, Bank of America and Citi set 2024’s S&P 500 price targets at 4,500, 5,000 and 5,100, respectively, according to Charlie Bilello, chief market strategist at Creative Planning. The S&P 500, of course, closed the year at 5,881.

Looking back at last year’s predictions teaches us three things. First, you can be correct on your interest-rate prediction and yet be wrong on how the market will react to the actual outcome.

Second, there’s a false equivalence drawn between disappointing interest-rate predictions and a downturn in the stock market. Media narratives are often created after observing the market reaction.

Third, predicting the right outcome is not a resource or expertise issue. Banks have both in abundance and, yet, they can get it wrong.

Hence, as individual investors, with far fewer resources, we’re better off ignoring these interest-rate predictions and preparing, instead, for potential outcomes.

Right expectations, wrong forecasts

Forecasts and expectations may look similar, but they are different. My friend Eugene Ng puts it best: Forecasts rely on knowing when something will occur. Expectations, on the other hand, are the acknowledgement of what’s likely to occur without professing insight into when it will happen.

For example, it’s reasonable to expect the stock market to fall by 10 per cent or more sometime in the future. After all, history has shown that corrections are a common occurrence.

Forecasts, on the other hand, will try to pin this correction to a specific point of time. For example, market analysts often indulge in predicting whether a market correction will happen in 2025.

Such behaviour can prove costly. As an example, the S&P 500 undergoes a market correction once every two years, according to wealth manager Ben Carlson. So, you know the odds.

But there’s an important distinction: knowing the chances of a market downturn does not tell you when it will fall. While a market correction has historically occurred roughly once every two years, it does not guarantee that it will happen like clockwork. In fact, a look at the past reveals long periods of time without a correction. For instance, there were no significant pullbacks between 2012 and 2014, a span of three years.

Hence, if you waited for a correction during this period, you would have sat out a significant portion of the bull market.

Get smart: Predictions don’t count. Preparations do

If predictions are unreliable, what can investors do instead? Forecasts are popular because they seem to remove a key source of investor anxiety arising from uncertainty over what will happen next. However, the key is to identify the roots of your fear, in my view.

If your anxiety stems from the daily market fluctuations, consider removing the column showing the daily change in stock prices from your portfolio. This metric should have no bearing on your investment decisions anyway.

If your fear comes from the potential lack of funds, there is nothing wrong in taking some money off the table if it puts your mind at ease. Alternatively, if regular dividends provide comfort, consider increasing your allocation to income stocks to boost your passive income.

Here’s the thing: if uncertainty is the only certainty in the future, then having a calm mind is an underrated factor.

As Housel points out, Napoleon defined military genius as the man who can do the average thing when everyone else around him is losing his mind.

The same principle applies to investing. In my eyes, calmness can be achieved by having the right expectations, and preparing well for any market turbulence even when we don’t know when the market will fall.

If you are prepared, you will have fewer worries. If you worry less, you will stand a better chance of doing better than average. And that’s more than any investor can hope for, whether the forecasts are right or wrong.

The writer does not own any of the shares mentioned. He is co-founder of The Smart Investor, a website that aims to help people invest smartly by providing investor education, stock commentary and market coverage.