Here we are again at the start of a new decade. As I sit here pondering the future, I can’t help but think back to the year 2000 and the enthusiasm and hope that year brought to the world (after the passing of the Y2K fear, of course). The stock market was near an all-time high. The power of the Internet was in full force, and many felt that we had truly experienced a significant “paradigm shift.” Stock ownership by individuals was at an all-time high, as was employment. Growth stocks were all the rage and anything even vaguely associated with the Internet was golden. I recall clearly my younger colleagues thinking that “value stock” was just a euphemism for a stock that didn’t go up.
Little did we know at that time that the next ten years would be so fraught with upheaval and disaster. The bear market which began in 2000 was bad enough, but the terrorist attack of 9/11/2001 ushered in a new era of fear and conflict which persists even today (just visit an airport for confirmation of this). Military conflicts in Iraq and Afghanistan, which began in the decade, also persist to the present. Low interest rates, easy credit and nudging from the government encouraged all Americans to become home owners. These same forces allowed speculators to make fast money in real estate, which created a sizable bubble in that market. Massive amounts of new mortgages and clever ways of repackaging them led to another boom and then a bubble in mortgage-backed securities. New legislation allowed banks to leverage their balance sheets to unprecedented levels. All of this came tumbling down late in 2008. For the first time since the 1930’s, stock returns were near zero for an entire decade.
This review isn’t meant to create any more despondency or rehash the negative aspects of the past. Rather, it is meant to be a note of caution to anyone who reads the many forecasts now being published about the future of the economy and stock market. Nils Bohr, the famous physicist, famously quipped, “Prediction is very difficult, especially if it’s about the future.” Think back to the forecasts which were made in early 2000. Did any of them contain the possibility of the 9/11 attacks? Or the US invading Iraq? Or a three-year bear market? Think back to the forecasts made in early 2009. Did any of them suggest that the S&P 500 would be up by 23%? I recall many forecasts suggesting the S&P 500 would go to 600, 500 or even 400, but no one I remember was predicting 1,100.
I don’t mean to dismiss forecasts entirely; clearly they serve some purpose. Forecasts satisfy investors’ need for clarity and certainty. The logic and rationale behind well-reasoned forecasts are often helpful and useful. Yet, making any significant investment decision based on any given forecast is very dangerous in my opinion.
In my early years on Wall Street, I worked for a firm whose equity market strategist was highly regarded for his ability to accurately assess Fed policy, whether it was accommodative, neutral or restrictive. His skill in predicting stock market trends, on the other hand, was famously weak. In fact, one of our clients found his work valuable only because they could usually make money doing exactly the opposite of what he recommended! I recall that one year his predictions were uncannily accurate and the market did exactly what he thought it would. After this, the client mentioned above stopped using the firm’s research…
Anyway, I recall one meeting where this strategist was laying out his feelings, impressions and predictions for the upcoming year. He discussed his views on interest rates, Fed policy, currency factors, the economy, funds flows, investor sentiment, etc. The list was endless, and for each positive he was able to conjure up a corresponding negative. Finally (and to the great joy of all in attendance), he began to summarize and offer his final conclusion. “I think,” he said, “that the stock market this year will…” Here he paused for a moment, thoughtfully stroking his chin and looking a bit absent-mindedly at the ceiling. “I think that the market will exhibit… volatility.” Although no one in the room said it out loud, we were all thinking, “Volatility? Oh, so you think that stock prices will go up and down? Thanks a lot for that!”
Now that I’m older (and at least more experienced, if not wiser), I can better see the value of that seemingly useless forecast. The value is this – complicated forces are impacting stock prices daily, and to reach a simple conclusion (up or down, for instance), grossly misrepresents the complexity of the investment decision making process.
I try to reduce this complexity a bit by not worrying too much about the big picture stuff and focus most of my efforts at the stock level. It’s a “bottoms-up” approach that is battle-tested and has served me and countless other investors well. I continue to think we are in a new bull market (a 65% bear market rally is as rare as yeti fur), which is likely to last several years. I continue to find pockets of undervaluation in many sectors. The massive amount of cash on the sidelines needs to go somewhere and given the historically low returns offered by bonds right now, I suspect it will eventually find its way into stocks. Finally, I think sentiment is still very cautious. We have not seen retail investors plow back into this market yet. We have heard many stories of investors or their advisors who sold stock in early 2009 and to this day remain in cash or short-term bonds. Not until I see wide-spread enthusiasm for the stock market will I begin to worry that the bull market is over.