Happy New Year?
It’s that time of year again when wall street and stock market followers all ask, what will next year bring us in returns? What are your price targets for the S&P 500? Of course, some will say they are right more often than not. However, if you look, most years, forecaster averages are wrong.
Let’s look at 2022, for example. According to Yahoo Finance, “As of November 2021, the median of 12 forecasts was 4,825, according to Bloomberg. The highest was 5,300, from Brian Belski of BMO. The lowest was 4,400, from reliable bear Michael Wilson of Morgan Stanley” Source (Yahoo Finance). Even that ‘reliable bear’ was off by almost 15%. How can this be? I thought wall street was full of the brightest and most brilliant out there. Don’t they spend millions and millions of dollars on research? Yes, they do! But guess what? NO ONE CAN PREDICT THE FUTURE! And if they could, they wouldn’t publish it anywhere!
Why do they get it wrong?
First, it’s good to understand that forecasters use different approaches for predicting (or guessing) where the market will end up.
Macro vs. Micro:
Depending on your experience, you might think these words have different meanings, but in the investing world, they mean Top Down vs. Bottom Up. Note: I said Bottom Up, not Bottoms Up! I know this is New Year’s, and some may partake in certain beverages, but let’s stay focused. Top Down (or Macro) means to look at the overall economy, things like inflation, economic growth, job creation — the big picture stuff. In contrast, Bottom Up (or Micro) analysis looks at variables such as individual company earnings, growth, product development and expansion, etc….
Quant vs. Fundamental vs. Technical
You can refer to our other blog on the different approaches to asset allocation for some additional context.
As a quick refresher, analysis can be done in a few different ways:
- Quantitative (or Quant): A computer algorithm/formula generates a result based on input data. Many people say quant takes human emotion, and thus chances for bias and errors out of the equation. Having a degree in Mathematics, I can tell you that is not entirely correct. Humans create the algorithms and choose what data to include, those algorithms may still include biases and errors. This doesn’t make quant wrong or useless; far from it, we are big believers in Quant, but if you follow our work, you know we take a Multi-Dimensional view (including many different ingredients).
- Fundamental: This is an analyst, portfolio manager, or team of individuals coming to conclusions based on various data points. And yes, some data points might be experiential (which is hard to put into a computer algorithm). Many fundamental approaches also include quantitative research, but our significant distinction between the two is who is mainly making the final decisions. With fundamental, it is humans. With Quant, it is robots — I mean an algorithm.
- Technical: This is chart reading. Those who follow technical analysis believe that most everything derives from the stock price (which is also what most quant or fundamental managers believe if they follow the efficient market hypothesis). For some reason, technical analysis has not been included in the traditional financial advisors’ toolboxes; we think that should change. Indicators are the tools that technical managers utilize. There are many different indicators. If there is interest, we can do a blog about technical indicators (reach out to us here to let us know). Interesting technical analysis could be done with human interpretation solely or with the help of automated algorithms. A conversation around art vs. science could be had, but we’ll leave that for another day.
“This is all good and well,” you might say, but what method is correct? What approach will tell me where the market will finish this coming year?
Well, they are all good, and they can all make a prediction about where 2023 will finish and how it will go about getting there. However, to know which one will be closest? Come back on December 30, 2023, and I will tell you who was correct! In all seriousness, we believe truly diversified portfolios use all the tools available. So some predictions will be accurate, while others will be wrong, but that is OK. With investing, what is ‘wrong’ one year, could be ‘right’ the following year. Therein lies the secret to our method. Being right & wrong at the same time allows you to benefit from what our friends at ReSolve call Rebalancing Premium. We’ve referred to it before as Rebalancing Alpha, or simply it’s “Buying Low & Selling High.” Isn’t that the secret to investing we’ve all heard for years? So grab your popcorn and keep reading, it’s getting good.
Weather Reports and Forecasting
There’s an old saying that goes, “It’s the bus that you don’t see that hits you.” Namely, if you see the bus coming, you get out of the way! Like stocks, we can’t see pandemics, terrorist attacks, massive fraud, or other unforeseen variables coming. The impact of unpredictable variables could be as trivial as when the low-carb diet was all the rage; certain restaurants and food companies had their earnings impacted and had to adjust their menu or products. In the corporate world, it’s called “pivoting,” but that’s a polite way of saying they were wrong. Now, don’t get me wrong, it’s good to pivot, and we like managers and investing styles that can pivot based on market conditions; those are the tactical strategies we’ve referred to above.
What is the solution?
So do we ignore all the predictions that are out there? No. At the very least, they are significant indicators of other market participants’ thinking. Don’t treat them as gospel, thinking they will be correct. Instead, our motto is, “Do Not Attempt to Predict the Future, but instead Prepare for the Future, regardless of what happens!” Even though the weather report says sunny skies, maybe you still keep an umbrella handy. Thus, maintain a properly diversified portfolio focused on goals and time frame.
If you are an individual investor reading this, be sure to actively communicate with your financial advisor about your goals, time frame, and feelings. Your advisor is there to help you, just like a doctor; if you don’t tell them what you are going through, they can’t help.
If you are a financial advisor reading this, then be sure to add true diversification to your clients’ portfolios. A basic 60/40 is not the answer. Traditional asset management is antiquated and fails your clients. Instead, follow a Multi-Dimensional Asset Allocation approach!
Make a Better Wheel
Those that know me know that I love analogies. I’m not going to bring the cookie up, but you can certainly read our blog here on cookies.
I am going to mention the wheel. When invented initially, the wheel had only a few spokes. If a spoke broke, the wheel broke. The spoke kept the wheel together and carried the weight across the wheel. A Multi-Dimensional Asset Allocation works the same way. If the portfolio has just stocks & bonds, it is essentially a two-spoke wheel. What happens when one or both break (like we saw in 2022)? You crash! And you don’t want to crash! “Wait a minute! A two-spoke wheel is just stupid; no one would do that,” you might say. However, most investors and advisors build just two or maybe three-spoke wheels. Why? It works a lot of the time. Just like you don’t need an umbrella, most of the time. However, f you get caught in the rain without one, you’ll get wet. In portfolio management, ‘getting all wet’ possibly means not meeting your retirement or other financial goals, or having a significant amount of stress during the down/wet periods.
For example, the 60/40 stock/bond portfolio has worked for many years—recently. The key is ‘recently,’ our mind tends to put more weight on recent events. Looking back at history, the traditional 60/40 stock/bond portfolio has had many extended periods of flat real returns. Don’t get me wrong, we love traditional low-cost 60/40 portfolios, but not for 100% of an investor’s allocation, or even 50% or their allocation.
Multi-Dimensional Allocation is like having many different spokes in the wheel. Yes, include the two main spokes; have a strategic stock & bond approach. However, also include various tactical managers by selecting managers that use different methods (quant, fundamental & technical analysis); each different approach is like adding an additional spoke to the wheel. Also, include alternative assets and strategies that are non-correlated to stocks & bonds; these add additional spokes to the wheel.
I think you get the picture. Investing shouldn’t be about getting to the finish line the fastest; it’s about getting to the finish line while still standing, avoiding as many pitfalls and bumps as possible! So focus on being able to retire, send your kids to college, buy your first home, reaching your financial goals. Don’t focus on beating the stock market each year. Don’t focus on year-end predictions. Instead, focus on building and maintaining truly diversified portfolios, or what we call Multi-Dimensional Portfolios.
We are here to help.
Our firm was built by successful financial advisors, for successful financial advisors, which is a significant distinction from other firms. So, if you want to do better for your clients, free up your valuable time to focus on planning or other aspects, differentiate & grow your firm, and provide true diversification to benefit your clients, then let us help.
We simplify the complexity by doing all the research and portfolio construction using our unique multi-step process, which combines qualitative & quantitative manager/strategy selection. As a result, the portfolios are easier to maintain and do not require onerous trading, yet provide significantly more to their clients.
Reach out to us to set up a time to review your current portfolio solutions, and we can compare them to our multi-dimensional portfolio solutions.
Are you an Investment Advisor?
Want to make better portfolio decisions and have more time to serve your clients? Learn about our multi-dimensional asset allocation approach by requesting a consultation.
We partner with a number of Investment Advisory firms and can introduce you to a qualified financial advisor that follows our approach.
Are you an Individual Investor?
If you’d like to be introduced to a Certified Multi-Dimensional Advisor or have a conversation with us about your goals