Investing isn’t about certainties and absolutes. Outcomes are challenging to predict with any high degree of confidence, and the more likely an outcome is to occur, the more likely that result is fully reflected in market prices.
Take economic releases. Investors can look to any number of sources to get a consensus estimate of what forecasters expect GDP growth to look like at the beginning of any quarter. One thing investors know with a decent bit of certainty is when the Bureau of Economic Analysis (BEA) will release the coming quarter’s initial estimate of GDP growth, so there’s not much of a market to be made around the timing of that release. Often, however, the actual economic data that provides clues on the pace of GDP growth doesn’t line up with the consensus forecast. As a result, those forecasters will tweak their projections, and while actual GDP growth might be double or half what was initially anticipated, the consensus estimate as of the GDP release date is often much more in-line with the BEA’s calculations. As John Maynard Keynes is rumored to have said, “When the facts change, I change my mind. What do you do, sir?”
There’s money to be made when investors think economic growth projections are off-base. Buying bonds can be profitable if weaker growth pushes interest rates lower and selling bonds can help avoid losses if stronger growth pushes interest rates higher. Investors can tilt into or away from stocks that are more sensitive or less sensitive to economic growth.
The same is true when investors think earnings projections – for individual companies or the broader equity market – are off-base. Stock prices are based on expected future earnings, so investors will want to sell stocks when expectations are too optimistic or aggressive and buy stocks when those expectations are too conservative or may not incorporate developing opportunities.
Astute investors think in terms of probabilities and potential outcomes, though to be fair, very few investors were likely thinking of a pandemic as a potential outcome in mid-2019. Those astute investors ask what might happen and how likely that outcome is to occur. They’re looking at multiple scenarios and forming multiple plans of action to potentially implement depending on how events actually play out. Those investors might initially plan portfolios around what they perceive as the most likely outcome, but they have something of a decision tree that helps them navigate an evolving market. Those investors might have made moves to prepare for what was forecast by many commentators to be an imminent recession over recent years, but observant investors aren’t still waiting for that “imminent recession”.
What has already transpired is something we know with relative certainty, but there may be differences of opinion on how to interpret events. We do know that the S&P 500 has appreciated about 9.3% per year on average since 1980. It’s highly unlikely that the benchmark would return that exact figure in any one year, so for purposes of illustration, consider a return between 5% and 15% – with 9.3% pretty much in the middle – “average”. Returns, however, fall in that range just a bit more than 20% of the time, 22% to be exact, meaning that returns are quite a bit different than average the vast majority of years. Investors have opinions, and opinions make for markets, but no investor knows with any high degree of certainty exactly how 2025 will play out. Past results are indeed no guarantee of future performance, but if history is a guide, investors can head into the coming year with a reasonable degree of confidence that the return on the S&P 500 won’t be average!
