Former Secretary of Defense Donald Rumsfeld famously said about national security intelligence: “There are known knowns. We also know there are known unknowns. That is to say, we know there are some things we do not know. But there are also unknown unknowns, the ones we don’t know we don’t know.”
Former Secretary Rumsfeld’s tongue-twisting logic also applies to the public securities markets and how people make decisions about investing.
Wall Street analysts, talking heads on TV and social media stars love to talk about what they think they know. They constantly make predictions and market forecasts, even though it’s pretty clear such predictions and forecasts have no actual predictive value.
When it comes to predicting the future of the economy and public securities markets, there are certain things we will never know and can’t know with any predictive certainty. Investors will be better off acknowledging these realities and investing accordingly.
We don’t know how the economy and markets will perform in the near future
We don’t know how the economy and the markets will perform the remainder of this year, next year or the next three years. No one does or can know this — there are simply too many unforeseeable events that can cause the economy and markets to be altered, such as the recent pandemic.
Yet, every day we are bombarded with the latest economic and market news on topics like interest rates, inflation, bond yields and home sales, as if any one event will alter the course of the economy and markets. While they can help investors understand economic trends and data that affect markets in the short term, these news updates are mostly noise.
We do know that most investors will continue to seek out predictions on the economy and markets and that many will make decisions based on such unreliable predictions.
Why? There’s a burning human desire to want concrete answers to an unknown future. We are drawn to any analysis that looks like engineering with a certain outcome and definite answers. But finance isn’t a science with known data. Instead, it’s messy, with lots of unknowable information about the future and hundreds of data points that could affect each company’s profits.
We think we know that we should expect markets to continue to provide positive returns for the long term. Why do markets continue to go up? It’s because capitalism and innovation work to grow world economies, and because billions of people around the world want to improve their standard of living. It’s been the history of the U.S. and world markets for centuries. Companies like Amazon, Google, Apple and Facebook that currently dominate the markets didn’t even exist a few decades ago. New industries like 3D printing, artificial intelligence and others we can’t even imagine today will likely contribute to continued growth moving forward.
If you believe in the power of people and innovation, you probably have reasons to think that financial markets will generally continue on a growth trend.
No one can predict the future stock market winners
We can’t know the future new industries and companies that will excite investors and garner lots of attention, but we probably can reliably predict that many of them will be priced for perfection.
We can also likely predict that many of them will not survive or be the big winners. Stock market history is littered with companies that were “the next big thing” yet did not perform to expectations. It turns out picking big winners in individual stocks is really, really hard, or you must get really, really lucky. In fact, most stocks do not outperform Treasury bills.1
Despite these facts, we can be confident that the media and many investors will continue to chase these stories. We will continue to hear about people who got lucky and picked the big winners. And while it does happen, the stories can cause investors to make big mistakes in trying to get lucky. You could end up losing significant wealth trying to pick the next big winner.
We do know that being broadly diversified is the most efficient way to benefit from the market gains of the next big winners because your portfolio is likely to include them, while mitigating the impact of most stocks, which have negative returns.
We don’t know if investors will learn these lessons
Just like every parent thinks their children are above average, many investors don’t or can’t understand their own biases and flawed investment expectations. While they may believe that all the above applies to others, they don’t believe such human quirks apply to themselves.
Many investors ignore the evidence and the lessons learned because the desire for some level of certainty in an uncertain market environment is so powerful. In many ways, the most difficult issue for successful investors to manage is their own fears and unrealistic expectations. Unfortunately, such fears and unrealistic expectations often lead to worse returns than the markets provide because of poor investor behavior.
One of the consistent themes we write about is letting go of the understandable desire for predictability and certain outcomes in an uncertain world, as difficult as it may be. This desire for control and predictability only serves to perpetuate the myth that market outcomes can be predictable.
Instead, let’s embrace the uncertainty, make investment allocations that are appropriate for our risk tolerance and financial goals, and let the markets work to hopefully better outcomes.
Looking to pursue a long-term investment strategy or for help maintaining discipline? Contact an advisor at Wipfli Financial for assistance.