Predicting Surprises

When I first started working as a Financial Advisor at Morgan Stanley in 1998, the dot com frenzy had begun and the tech bubble was growing larger and larger. Morgan Stanley had two chief strategists, Byron Wien and the late Barton Biggs. Barton Biggs was widely considered to be Morgan’s chief bear, while Byron Wien was more of an optimist and generally had a bullish view of the markets. At the end of each year, they would each make their list of the top 10 surprises they were predicting for the year to come. Some of these were about the markets, but some were about geopolitical events and other things. While their predictions were certainly entertaining, they often had diametrically opposed views and yet they were two of the top strategists on Wall Street. What was I supposed to do with this information?

It was then that I realized that trying to predict what was going to happen in the short-term in the markets is anyone’s guess and that perhaps more harm than good could come from trying to do so.

Rather than trying to predict short-term moves in markets I embraced a long-term view and learned everything I could about modern portfolio theory and how to create portfolios that were well diversified and allocated across multiple asset classes.

Lately I’ve been wondering what Barton Biggs would have had to say about the run-up in meme and large cap growth stocks over the past few years. We haven’t seen spreads between growth and value so high since the late 90s. A lot of this seems to be fueled by meme investing, where certain securities have been singled out and gained a cult like following online. Rarely does this end well for these investors and I am worried for those who play in these games of musical chairs.

David Booth published a great article the other day, titled, Meme Investing? Try Human Ingenuity Instead. In it he states that, “when Wall Street or meme investors think they can capitalize on “mispricing,” they’re not betting against Wall Street so much as they are betting against human ingenuity.” I think what Booth means here is that by trying to pick and choose individual stocks that have the greatest chance of running up in the short term, you run the risk of missing out on the performance of all of the other companies in the global market. You also take on much greater risk when investing in individual securities than you do when embracing the broader markets. Booth states that he is, “referring to the millions of people working hard to maximize the value of their companies, and millions of investors trying to make the best possible trading decisions based on all available information. Sometimes speculators get lucky, and sometimes they don’t. Regardless, I don’t call what they’re doing investing. I call it speculation—even gambling. Buying the market is a totally different approach. It’s investing in human ingenuity. People working to maximize the value of public companies are innovative and resilient. They adapt to improve products. They create new processes to solve problems. While you can’t predict what any one person will do on any given day, you can predict that humanity will persevere. The market reflects this simple truth.”

Read the article if you have time. It is an excellent introduction to efficient market theory, which supports broadly diversified index investing. Markets go up and down in the short-run but over the long-run human ingenuity prevails and the long-term trend is consistently up as you can see in the Morningstar Ibbotson chart below of Stocks, Bonds, Bills, and Inflation from 1926-2020.

Ibbotson SBBI 1926–2020
A 95-year examination of past capital market returns provides historical insight into the performance characteristics of various asset classes. This graph illustrates the hypothetical growth of inflation and a $1 investment in four traditional asset classes from Jan. 1, 1926, through Dec. 31, 2020.

Small and large stocks have provided the highest returns and largest increases in wealth over the past 95 years. As illustrated in the image, fixed-income investments provided only a fraction of the growth provided by stocks. However, the higher returns achieved by stocks are associated with much greater risk, which can be identified by the volatility or fluctuation of the graph lines.
Government bonds and Treasury bills are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while stocks are not guaranteed and have been more volatile than the other asset classes. Furthermore, small stocks are more volatile than large stocks, are subject to significant price fluctuations and business risks, and are thinly traded.

About the data
Small stocks in this example are represented by the Ibbotson Small Company Stock Index. Large stocks are represented by the Ibbotson Large Company Stock Index. Government bonds are represented by the 20-year U.S. government bond, Treasury bills by the 30-day U.S. Treasury bill, and inflation by the Consumer Price Index. Underlying data is from the Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook, by Roger G. Ibbotson and Rex Sinquefield, updated annually. An investment cannot be made directly in an index.

Barton Biggs wound up being right about the tech bubble in the late 90s. It did burst, but he also called it so early that he appeared “wrong” for years before he was proven right. The good news is that when you embrace a diversified approach to investing, even when certain areas of the market seem subject to irrational exuberance, you can have confidence that other asset classes in the portfolio will help keep your portfolio afloat even if you do see a big sell-off in one piece of a portfolio.

If you’d like to schedule a review of your portfolio to ensure that you are well diversified, please schedule a 15 minute no-cost, no-obligation call to see how we can help.

Any opinions are those of Kathy Reisfeld or Rhinebeck Wealth Advisors and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results. Diversification and asset allocation do not ensure a profit or protect against a loss.

search previous next tag category expand menu location phone mail time cart zoom edit close