Market predictions could go awry; stick with long-term investment plan

LAST year was surprising in so many ways. Who could have predicted a double-digit rise among the broad global stock markets, 26 per cent for the S&P 500 Index, and a 55 per cent rebound by the Nasdaq? This is against the backdrop of the fastest interest rate hikes by the Federal Reserve in over four decades.

What was even more surprising was how resilient and strong the US and global economies remained throughout that period.

Most people may not remember this, but as 2022 came to a close and we entered 2023, a plethora of forecasts said interest rates had likely peaked. The forecasters spoke with a common voice that inflation was starting to decline; rates would begin to fall, and the Fed would cut rates in 2023.

But these forecasts were pushed back repeatedly throughout the year, and we ended 2023 at peak interest rates and no rate cuts in sight. As a result, fixed-income market returns were negative for most of last year, until a year-end rally brought it back into positive territory.

It is therefore ironic that as we begin 2024, like a rerun of a bad soap opera, we are seeing another round of confident forecasts from the so-called experts parading forecasts of Fed rate cuts and falling interest rates.

Memories are short and there is naturally little mention of the nearly universal failure to correctly predict the direction and magnitude of central bank policy, interest rates, and of course, market returns. Little surprise that none of the strategists looked back at their past forecasts as another year passed and another forecast is made. It is a strange annual ritual that many people still follow and spend time on.

Human beings are not known to have the ability to predict the future. We don’t even know how long our new-year resolutions will last. We cannot control our own behaviour, let alone predict ecoomic activity and the behaviour of tens of millions of participants in financial markets. The constant failure throughout last year was the inability to predict the minds of just the 12 voting members of the Federal Reserve.

As famed economist John Galbraith put it: “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” But this is not just wisdom from the West. Chinese philosopher Lao Tzu from the sixth century BC said: “Those who have knowledge, do not predict. Those who predict, do not have knowledge.”

After three decades of experience investing billions of dollars in financial markets, I am still hesitant to answer questions from investors, clients and friends on where I think markets are headed or what the level of returns this year will be. With a healthy dose of humility, I am happy to admit and also confidently share that we all have little clue regarding where the markets will go over the next year. Those who say they know should be reminded of the quotes above.

What is more important is not just some pithy quotes from wise but dead men, but the overwhelming weight of evidence from the history of economics and financial markets. This empirical- and science-based approach to investing is the only way for us to overcome our mistaken focus on “getting it right”. Rather, we should focus on what has the highest probability of success or the most likely outcome.

Maybe, unlike last year, interest rates will come down and the predictions will come true. But we should always be open to the possibility that they don’t. We should also be wary that timing is always something that is even more difficult to get right than the direction of markets. If we had remained invested for the past several years, the effect of compounded annual returns means that, at the end of 2023, you would have enjoyed the tailwind of the markets giving positive returns in four of the past five years. Many people don’t realise what they’ve missed.

Therefore, we must also remove the idea that “safe is good” or “cash is king” when it comes to investing our money. If we are to learn anything from the recent cycle, it is that interest rates and inflation always go hand in hand. Even with higher interest rates for our fixed deposits and Treasury bills, inflation is running higher than that.

This meant that our purchasing power was eroded even at an interest rate of 3 to 4 per cent, as inflation exceeded that. If interest rates do fall, then fixed-income assets will indeed give much better returns, thanks to higher starting yields and capital gains. However, the only sure way to beat inflation is to invest in equities over the long term. Bonds have held up well, but have been much more volatile and correlated to equities in recent years.

The effect of compounding market returns as compared to fixed deposits is clear in the accompanying chart, and is true for all long-term investments but especially for CPF and SRS monies. In every period of one year, three years, five and 10 years and longer, the stock market and a balanced portfolio have outperformed any fixed deposit or yield product. That is why long-term investors stick to low-cost, passive index investing on our platform, and the ones that persisted through the volatility in recent years are the ones that have won out.

This year, let go of what we cannot control – the market direction, economy, or the circumstances of war and pandemics. Focus on the only thing actually within our control: our behaviour. When you make new-year resolutions about your physical health – to give up smoking and alcohol, or to exercise more and eat less – don’t forget to work on your financial health as well.

Resolutions on investing are typically made at the start of the year. However, these financial disciplines, once set up as regular plans and implemented through trusted advisers whether digital or offline, should be easier to sustain than going to the gym every week.

The trick is to keep it simple by setting up regular savings and investment plans. Developing ongoing good investing habits may be the most important thing we can do this year and the only certain way to better prepare for a future that will always be uncertain.

The writer is co-founder and chief investment officer at Endowus, an independent wealth platform advising more than S$6 billion in client assets across public, private markets and pensions (CPF and SRS)